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.
Also known as personal loans, unsecured loans, enable you to borrow money from a lender such as a bank or building society, without offering up any collateral.
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.
Unsecured loans are typically available on amounts of up to £25,000, which you repay, along with interest each month over a fixed term. You decide how long it will take you to repay the money, with loans usually available for between one and five years, but they can stretch to 10 years in some cases.
» COMPARE: Find a range of unsecured loans
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 manageable loan.
How much do unsecured loans cost?
The overall cost of an unsecured loan is determined by two factors: the interest rate and the term. The longer the term, the lower the repayments will be but the higher the total cost.
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 £215.68 and the total amount repayable £5,176.24. However, if the borrower took it out over five years instead, the monthly repayments would drop to £90.62, but the total amount repayable would rise to £5,437.14.
For this reason it’s important to give careful consideration to your repayment term and shop around for the lowest interest rate.
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 will depend on your credit score and the better your credit record, the higher your chance of getting the advertised rate.
How do I get an unsecured loan?
It’s quick and easy to compare unsecured loans on NerdWallet.
When you apply, the lender will need some basic information about you and your finances – essentially to check that you are who you say you are and that you can afford the repayments.
They will also run a credit check on you with a credit reference agency to find out whether you have previously missed or been late with payments.
For this reason, it is helpful to use a service that offers a free eligibility checker. These allow you to see whether your application is likely to be accepted without it having a detrimental impact on your credit record.
If a lender sees that you have recently applied and been rejected for a loan they may be less likely to accept your application.
Before you apply, think about whether you would like to repay the loan early as some – but not all – lenders will impose early repayment charges.
The pros and cons of unsecured loans
- Your repayments will usually be fixed each month making budgeting easier.
- You can borrow more than you would be able to with a credit card.
- Interest rates are lower than rates on most credit cards.
- If you want to overpay or repay your loan early, you may have to pay a charge.
- Minimum terms are usually a year even if you are able to pay it off faster.
- Minimum loan sizes are often £1,000 so you may have to borrow 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.
0% credit card
If you only want a small loan, have a strong credit record and are able to repay the money in a short space of time, you may be able to borrow the money interest-free by using a 0% credit card that offers no interest on new purchases for a set period of time.
You can vary repayments each month but you need to repay the money before the 0% period ends, otherwise high interest charges will kick in. But using a credit card in this way is only really comparable to an unsecured loan if the money is for a purchase as most credit cards will charge a fee for taking out cash.
» COMPARE: 0% credit cards
Second charge mortgage
If you do not have a good credit record and are struggling to get the loan you need on an unsecured basis, you may be able to use a secured loan – often known as second charge mortgages – so long as you own your own home. As the loan is linked to your property, the lender has more security, and as a result, the interest rate may be lower than unsecured loans. You may also be able to borrow a larger sum. The downside, however, is that your home is at risk if you struggle to keep up with repayments.
» COMPARE: Second charge mortgages
For homeowners, remortgaging may also be an option. By switching to a new mortgage – and borrowing more than the existing debt you owe – it’s possible to ‘unlock’ some of the equity in your home and use that money to repay your debts.
However, the downside is that you will be repaying the money over the length of your mortgage term, rather than just paying it back over a few years as you would with an unsecured loan. So even if you get a great deal on your mortgage rate, you could end up paying much more interest overall. It may also not be an option if your credit rating has deteriorated since you took out your mortgage.
» COMPARE: Find remortgaging offers
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Rachel Lacey is freelance journalist with 20 years experience. She specialises in personal finance and retirement planning and is passionate about simplifying money matters for all. Read more