What is an Unsecured Loan?

An unsecured loan can be a simple way of borrowing money, whether you have a big expense on the horizon or other loans you want to consolidate. Find out more about how much you can borrow, over what length of time, and the pros and cons of this type of loan.

Joel Kempson, Rhiannon Philps Last updated on 21 December 2022.
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What is an Unsecured Loan?

Unsecured loans, also known as personal loans, enable you to borrow money from a lender such as a bank or building society, without offering up any collateral as security in case you default on the loan.

This is in contrast to secured loans, where the lender insists you put up some security – normally your home – that it can claim if you don’t repay the debt.

You can typically borrow between £1,000 and £25,000 with an unsecured loan, which you then need to repay, along with interest. You decide how long it will take you to repay the money, with loans usually available for between one and seven years.

What is an unsecured loan?

Taking out an unsecured loan involves borrowing money from a lender, which you repay over a set period of time with interest. You usually make your repayments each month and the loan term is often between one and seven years.

It is called an unsecured loan because you do not put up any kind of asset as security. What size loan a lender works out you can borrow and at what interest rate will usually be based on your credit history and an affordability check which will be based on your current financial circumstances.

» COMPARE: Find a range of unsecured loans

How do unsecured loans work?

Most typical unsecured loans work in a similar way. You will apply to borrow a certain amount of money from a lender and, if approved, you will repay this amount (plus interest) in fixed monthly instalments over the agreed period.

You can often borrow between £1,000 and £25,000, although you may be able to borrow more or less depending on the lender and your situation.

If you miss a payment, you may face late payment charges and it could be recorded on your credit file. If you fail to repay the loan, the lender could take you to court to get back the money it is owed.

Before applying for a loan, many lenders will allow you to check your eligibility first. This allows you to see if you qualify for a loan, reducing the chances of applying for a loan and having your application declined.

To see if you are eligible, you need to give the lender some personal and financial details, and the lender will also run a soft credit check. This check won’t affect your credit score.

If you choose to formally apply for a loan, the lender will run a hard credit check which will appear on your credit report.

What can I use an unsecured loan for?

Unsecured loans can be used for major expenses you may not be able to cover with your savings, such as a new car, home improvements or a wedding.

Alternatively, if you have a handful of debts with different creditors, you can consolidate them into one more manageable loan.

» MORE: Our guide to debt consolidation

Types of unsecured loan

When you hear people talk about unsecured loans, they are likely referring to the wide range of both short and long term loans offered by banks, building societies, credit unions, and online lenders.

Some examples of unsecured loans include bank loans, guarantor loans, payday loans and student loans.

Although they are not a loan, credit cards are also classed as unsecured lending. When you spend money with your credit card, or any other line of credit, you are using a type of borrowing that is not secured against your home or any other asset.

How much do unsecured loans cost?

You can see how much a loan costs over the course of one year by looking at the APR, or annual percentage rate. This figure includes interest charges as well as any fees, which makes it easier to compare the costs of loans from different lenders.

The overall cost of an unsecured loan is determined by two factors: the interest rate and the term. The interest rate you are charged will depend on the lender and your credit score. If you have a poor credit score, you will be viewed as a riskier borrower by the lender so you are likely to be offered higher interest rates.

The repayment term also affects how much a loan will cost you. With a longer term, the repayments will likely be lower but the total cost of borrowing could be higher because you’ll be paying interest for longer.

Take the example of a £5,000 loan with an APR (annual percentage rate) of 3.4%. If the loan was taken out over two years, monthly repayments would be £215.79 and the total amount repayable £5,179.

However, if the borrower took it out over five years instead, the monthly repayments would drop to £90.73, but the total amount repayable would rise to £5,444.10. This means that the fees and interest add up to £179 on a two-year loan, but £444.10 on a five-year deal.

You may be able to reduce the amount of interest you pay overall if you repay your loan early, although you could have to pay early repayment charges.

It’s important to note that lenders will advertise loans with a ‘representative APR’ but the lender only needs to offer this rate to 51% of borrowers. The exact rate you get may depend on a wide range of factors such as your individual financial circumstances or credit score and the better your credit record, the higher your chance of getting the advertised rate.

» MORE: Calculate how much a personal loan will cost

How do I get an unsecured loan?

When you apply for an unsecured loan, the lender will need some basic information about you and your finances – such as your name, address, age, employment status, salary and living costs, essentially to check that you are who you say you are, that you live in the UK and that you will meet its lending criteria.

Lenders will then run a ‘hard’ credit check via a credit reference agency to find out whether you have successfully managed to repay credit in the past or whether you have previously missed or been late with payments.

If a lender sees that you have recently applied and been rejected for a loan, it may be less likely to accept your application because it could suggest that you are in financial difficulty.

Before you formally apply for a loan, it’s worth checking your eligibility for a loan to see how likely you are to be approved. This won’t affect your credit score. Many lenders allow you to see if you qualify for a loan, and you can also check your eligibility on our site.

» COMPARE: Compare unsecured loans

Pros and cons of unsecured loans

Pros:

  • Your repayments will usually be fixed each month, making budgeting easier.
  • You can typically borrow more than you would be able to with a credit card.
  • Interest rates are often lower than rates on most credit cards.

Cons:

  • If you want to overpay or repay your loan early, you may have to pay a charge.
  • The minimum term is usually a year even if you are able to pay it off faster.
  • As the minimum loan size is generally £1,000, you may end up borrowing more than you need.

Alternatives to unsecured loans

The right deal for you will depend on your circumstances and, in some cases, there may be better alternatives.

You should consider the differences between an unsecured loan and a secured loan to see which option is the right form of borrowing for your situation. A secured loan could allow you to borrow a larger sum and offer lower interest rates, but your property could be at risk if you default on the loan.

» MORE: Secured vs unsecured loans

You may also consider borrowing from friends or family. If you choose this option, make sure you agree on how the money will be repaid, and put this in writing to try to avoid any potential disputes.

You could also consider whether a loan is right for you at all. In some cases, it can be cheaper and simpler to use a credit card or overdraft for your spending, particularly if the sums you need are minimal or you have 0% offers available. However, as always, care should be taken if you go down this route as interest rates could be high and the debt on a credit card can quickly spiral out of control.

» MORE: Loan, credit card or overdraft?

Image source: Getty Images

About the authors:

Joel Kempson is a personal finance expert and writer at NerdWallet. He has previously written for Money.co.uk and Uswitch, as well as being quoted in the Daily Express, The Mirror and The Sun. Read more

Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more

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