The Beginner’s Guide to Personal Loans

a guide to personal loans

You’ve got your eyes on that new car, which looks tantalisingly shiny in the showroom window. Or perhaps you’ve got a killer business idea, and just need the funds to get it up and running. If only you had the cash to make it happen, eh?

Of course, there are a variety of financial options out there to help you out – some more attractive than others. Many of these come under the umbrella heading of ‘personal loan’, and could include credit cards, bank loans and home equity loans.

All involve the act of borrowing money, with the agreement to pay it back in the future, plus interest.

Sounds appealing, doesn’t it? These types of loan seem especially attractive if you need the money in a hurry. However, before you rush down to your local bank, take the time to read this handy guide to personal loans first, to make sure you understand exactly what’s involved.

A Complete to Guide to Personal Loans

1. Not all Personal Loans are Created Equal…

There are different types of personal loan out there. Here’s some of the main ones:

Secured Loans

These loans need to be secured by an asset, such as your home, which is why they’re sometimes called a homeowner’s loan. If you fail to make the repayments, your assets will be used to make up the shortcoming.

These loans are generally suited for those looking to borrow considerable sums of money.

Unsecured Loans

Unsecured loans are not secured by any asset. Instead, the bank looks at your credit history to ascertain how likely it is you’ll be able to afford the repayments. A warning for big spenders – you probably won’t be allowed to borrow over £25,000.

Credit Cards 

After being approved for a credit card (based on your credit history), you’ll be able to temporarily borrow an agreed amount, on the provision that you make repayments on a regular basis.

A big advantage of credit cards is that many banks offer a limited period of 0% interest, meaning you’ll only pay back what you borrow, as long as you complete the repayments within the specified timeframe. Generally speaking, you probably won’t be able to borrow more than £5,000 – so this option isn’t so great for larger spends. You can read our guide to credit card here.

Payday Loans

If you need money very quickly, and know you can pay it back equally as quickly, then a payday loan is an option. However, a strong word of warning – interest rates are incredibly high and could leave you repaying far more than you originally borrowed. It is advisable not to go this route (if possible). You can read our guide to payday loans here.

2. It’s Time to Take an Interest in Interest

If you’re taking out a personal loan, you’ll need to get familiar with the APR (annual percentage rate), as that’s the amount you’ll owe in interest each year.

You can read more on APR in this post What is APR? Knowing What APR is will help you get the best out of your borrowing. Many banks advertise their loans with a ‘typical APR’ – however, you should be aware that interest rates can vary.

If you prefer to know exactly how much you’ll be paying back each month, it is advisable to choose fixed rate personal loan. However, if you’ve got a bit more flexibility, a variable interest rate might be more appealing.

Variable rates as the name implies changes – normally in line with the Bank of England’s base rate. On a good day, this can mean you’ll be paying far less in interest when the rates are down. However, if rates go up, you’ll be paying more.

You can find out how much you’ll have to repay each month, using Moneyfacts.co.uk’s helpful loan calculator.

3. How Much Can You Borrow?

Generally speaking, you should be able to borrow up to £25,000 as an unsecured loan, presuming your credit history is squeaky clean. Anything over that, and you’re likely to be looking at a secured loan instead.

Banks like to encourage you to borrow more, so you’ll find that interest rates reduce as the loan amount increases. However, don’t be tempted to borrow more than you need to.

Remember, personal loan is a debt, and it’s always a good idea to avoid taking on debts at all cost. If you must borrow, avoid unnecessary debts and endeavour to keep your debt levels down as much as possible!

4. How Much Do You Have to Pay in Interest? 

This very much depends on the nature of your loan, plus your rate of interest. If you choose to spread the payments out over a longer period, this will mean your monthly repayment costs are lower, but it will massively increase the amount of interest you’ll be paying. Cue one happy, smiling bank manager!

For example, let’s say you borrowed £10,000 at a fixed interest rate of 7%. Pay it back over a three year period, and you’ll have paid a total of £1,100 in interest.

However, extend the repayment period to 10 years, and you’ll suddenly find you’re repaying £3,900. Yikes. Big difference!

5. Where Can You Get a Personal Loan?

You can walk into your local high street bank and start the application process, though many people prefer to shop around online to try to find the best deal possible.

It’s advisable to explore your options when considering a personal loan, as you could save money with a better interest rate if you locate a better deal.

When you’re exploring your options, don’t just consider the monthly repayment. Think about how much interest you’ll be paying in total, whether there are any application fees and what happens if you miss a payment.

Guide to Personal Loans – Questions to Ask

Before making a decision, it’s vital that you’re aware of all the terms and conditions of your loan. Here’s some things to consider, which are often overlooked!

Ask About Risk

Remember, any form of debt carries with it a certain element of risk. You may feel financially secure enough to repay your loan at present – but what would happen if you suddenly lost your job or became ill?

Of course, these are unlikely events, but it’s important to consider the worst-case scenario. Before arranging a personal loan, ask what happens if you miss a payment. Do they offer any form of flexible repayment, should the worst occur?

Get the Bigger Picture

Rather than working out how much interest you’ll be paying each month, look at the amount you’ll be owing in total. How much will you have to pay back over the course of the repayment plan?

Can you afford to give that much money away? It’s also important to factor in other costs, such as application fees.

Can You Make an Early Repayment?

Bear in mind that some financial institutions will actively discourage you from paying your loan off early. After all, they want to get as much money out of you as possible!

Your loan may even carry with it a redemption penalty, which you’ll have to pay if you want to complete your repayments early. It’s important to understand exactly what the terms of the loan are before you apply – to avoid any financial problems in the future.

Can You Afford It?

You’ll also need to consider how you’ll manage your repayments. Money management apps can be really helpful in terms of keeping track of monthly, weekly and daily outgoings – helping you to stay on budget and keep up with repayments.

Do You Need a Personal Loan?

Generally speaking, the best course of action is to avoid taking out a personal loan. Any form of loan tends to benefit only one person in the long run (here’s a clue – that’s not you!).

However, life does throw us unexpected curve-balls from time to time, and in certain instances, a personal loan might be the only viable option.

Your Turn…

What are your experiences with personal loans? Did you feel like you understood the loan when you applied? How did you find meeting the regular repayments? Was it worth it in the long run? We’d love to hear all about your experiences.

This post is part of the Debt Management series, you can read all posts in the series here.

Introduction to Managing Your Debt
What is APR: Get the Best out of Your Borrowing
Student Loans: A Guide to University Debt
The Complete Guide to Credit Cards

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9 Comments

  1. I once used the payday loans because I urgently needed money that week to meet some commitments which I seriously regretted. I guess I should have really asked myself if I needed the loan.

    To be honest, I am sure, there would have been better alternatives if I have sat down to ask myself that question.

  2. Thank you for taking the time to leave a comment. Payday loans should be avoided at all cost. The interest rates are significantly high and would in most cases leave you paying way more than you originally borrowed

  3. Great overview of the different types of borrowing options available. I’ve had loans right from age 18 to when I was in my early thirties. I hope never to get another one again!

    Looking back, I did always consider the interest rate but I was more interested in how much I could borrow rather than the amount of time it would take to pay the loans back. I would encourage anyone to take time to weigh up all their options, including whether they really do need a loan at all, before signing up to anything.

    From experience, getting a personal loan for something I wanted rather than needed was definitely not worth the amount of hard work I had to put in to pay it off!

    1. Absolutely, debt stops you from financial progress, as result, it is very important to ask yourself if you really need a personal loan in the first place.

  4. I really feel the vast majority of time – people don’t need loans. Unless it’s life or death – if you can’t afford it, don’t buy it.

    1. Mel, thank you for your comments. Absolutely, by and large the best path is to avoid taking out a personal loan, because any form of loan tends to benefit the lender.

      Nevertheless, life does throw us unexpected emergencies occasionally, and such, a personal loan might be the only possible alternative.

  5. Another source for personal loans is peer-to-peer lending. In the US the two main companies are Prosper and Lending Club. You can apply online and compared to banks, I understand that the rates are reasonable.

  6. There are so many loans around, but I think the most important part is to stop and question whether you need the loan. I’m a big fan of making extra money instead of resorting to a loan.

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