If you are interested in learning more about personal loans, then we have everything you need to know. From how they work to what sort of rates to expect – and even whether or not they will impact your credit score. If used correctly a personal loan can be a welcome injection of cash for that new car you are after, or a sound way to consolidate your existing debt. But in order to make it work for you, you need to know all the ins and outs. So let us guide you through it.
A personal loan is a loan provided by a bank, building society, credit union or private lender which is not secured against any of your personal assets, such as your home.
Also known as an unsecured loan, it is typically a fixed amount of money borrowed over a fixed period of time with a fixed interest rate (although variable rate interest rate loans are available).
Typically when you apply for a personal loan you will agree with your lender the amount you will borrow, the term over which you need to repay the loan and the interest you will be charged for the duration of the loan. You will then be required to make fixed monthly payments to pay down the balance of the loan.
So for example, you could borrow £12,500 at a rate of 2.9% for a term of three years. This means that you would be required to make monthly payments of £362.76 until you have repaid the loan in full. Therefore, the total amount you will have repaid over the three-year term would be £13,059.36, of which £559.36 will have been interest.
One thing to note is that you are able to make overpayments on your loan for free. If your loan was taken out on or after 1st February 2011, you can make partial overpayments on your loan without being charged — as long as they total under £8,000 in year. If they are above £8,000 in a year, then your provider is allowed to charge you if it has incurred a cost from you paying back the loan early.
Similarly, while you are allowed to pay back your loan in full, you may be charged an early repayment charge of around one to two months’ interest. How much depends on your individual provider.
When it comes to personal loan interest rates what you typically find is that the more you borrow, the lower your interest rate will be. Don’t be tempted to borrow more than you need just for this reason — that can lead to trouble. However, you should be aware of this aspect the market in case you are borrowing near a threshold of loan amounts. In that case, you may find borrowing just £100 more means you actually pay less in interest overall.
As mentioned, personal loan rates have different thresholds. So you may find that if you are borrowing under £5,000, you will be looking at a rate between 8.2% and 13.5%, while if you are borrowing between £5,000 and £25,000 it will be more like 2.8% to 3.6%. If you are looking to borrow an amount over £25,000, rates tend to vary much more, and many providers save their cheaper rates for existing customers.
When looking at personal loan rates it is important to know what is meant by APR (annual percentage rate). The APR is what you will owe on top of what you borrow. It is the advertised rate for the product, which means that it is offered to at least 51% of successful applicants. Therefore, it is not a guaranteed rate, and if you have a poor credit score you may find yourself being offered a higher APR.
Lenders will look at your credit score as well as your income levels when deciding whether or not to approve your loan application.
As a general rule, you need a good credit score in order to be accepted for loans with decent terms. Lenders are looking for applicants who have a proven track record of paying credit back on time. That’s not to say you won’t be accepted for a loan if you have a poor credit score, but you may find that it is priced at a higher rate as you present a bigger risk to the lender.
Lenders also tend to look at your disposable income levels. When making your application you will most likely have to provide information about your income and outgoings. They will look at how much you have coming in and how much you have available to you once fixed costs such as mortgage payments and utility bills come out.
Taking out a loan could have a negative impact on your credit score in the short term – but if you make your repayments on time and stick to the agreed terms, then this can be reversed in a matter of months.
The initial negative impact is largely the result of the application itself. An application for any form of credit can have an adverse effect on your score just because your lender will run a ‘hard’ search on your credit history. This leaves a footprint on your report, and lenders are not required to report to credit reference agencies whether or not the application was successful.
If you’ve applied for multiple loans this can also act as a red flag to lenders, as it could mean that you have been turned down for other loans or that you are trying to borrow more credit than you can afford. This is why it can be beneficial to thoroughly compare loan products, and maybe complete an eligibility checker before committing to a loan application.
It is also worth mentioning that your credit score is calculated by looking at how much debt you currently have, as well as many other factors. So if you are considering taking out a loan, just be mindful that this will show on your report as a form of debt and therefore may impact your ability to borrow more in the future.
If you are interested in a personal loan, what are the pros and cons of this type of product?
When it comes to personal loans, borrowers are often spoilt for choice. It is a competitive market with lots of options, so here are a few things you should keep in mind when choosing a personal loan.
Representative APR – This is one of the key elements of a personal loan, what rate of interest you are likely to be charged. As mentioned above, the APR is the advertised rate which 51% of successful applicants will get. You may end up with a higher rate depending on your personal circumstances. But looking at the APR is a good way to compare loan products, as the lower the APR the less you have to pay.
Monthly payments – Take a look at what your monthly payments will be. This will depend on the personal loan’s interest rate, how much you are borrowing and the term of the product. You can use loan calculators on comparison sites to change these elements and see which gives you a monthly payment amount that works for you. It is important to find a loan with a monthly repayment amount you can afford, as missed payments can have a disastrous effect on your credit score.
Early repayment charge – This is something to take into account if you feel you may be in a position to pay the loan off before the end of its term. Compare what you would be charged for an early repayment, or even look for a loan product which doesn’t have an early repayment charge.
Total amount repayable – Try to calculate the total amount you would have repaid by the end of the loan’s term. This will help you to understand the real cost of taking out the loan and make it easier to compare products.
Whether a personal loan is right for you depends on your own personal circumstances and what you are borrowing the money for. Loans can be a sound way to consolidate your debt and reduce your interest payments. Or they can be an affordable borrowing option if you are looking to buy a car, pay for a wedding or other big life expenses. They typically have a lower rate of interest than a credit card, and there are usually no fees attached.
However, there are some circumstances where a personal loan may not be the right fit.
If you want to put yourself in the best situation for being accepted for a personal loan, there are a number of things you can do.
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