If you want to borrow some money for home improvements or a new car a personal loan is often the answer. But do you know how to get the best deal?
Our guide looks at the different types of personal loans, explains the small print and shows how sometimes borrowing more can cost you less.
Secured vs unsecured
Personal loans are either secured or unsecured. Both allow you to borrow a fixed amount over a fixed term, usually at a fixed rate of interest.
When you take out a secured loan
you will need to offer an asset as collateral. The most common surety offered is your home so secured loans are often referred to as ‘homeowner’ or ‘home equity’ loans. Both second-charge mortgages and further advances from your existing mortgage lender are types of secured loan.
Putting property up as security makes secured loans less risky for lenders but more of a risk for borrowers: your home could be repossessed if you don’t keep up with repayments. This makes it priority debt, meaning you should repay this before unsecured debts.
Secured loans tend to be for large amounts – upwards from £25,000 to £200,000 in some cases. Repayment terms can be up to 25 years.
Unsecured loans tend to be for smaller amounts of between £1,000 and £25,000, normally repaid over terms between one and seven years. As the name suggests, you don’t have to put your house or any other asset up as security.
Both secured and unsecured loans will have a set repayment plan with monthly payments calculated to ensure the loan, plus interest, is paid off by the end of the term.
A handful of lenders offer flexible loans where borrowers can overpay and/or take payment holidays.
More can cost less
One anomaly of the banding system is that it can be cheaper to borrow a larger amount of money than you actually need.
Here’s an example from TSB. If you borrow between £5,000 and £7,499 you’ll pay a typical rate of 16.9%. But loans between £7,500 and £14,999 have an APR
of just 3.9%.
So if you borrowed £7,000 over three years you’d pay £246.26 a month and a total of £8,829.36. This includes a total interest bill of £1,829.36.
But if you borrowed £7,500 over three years you’d repay £221.02 a month and a total of £7,956.72. This means you’d pay just £456.72 in interest. Despite borrowing £500 more you’d pay £1,372.64 less overall than if you borrowed £7,000.
Eight main features of loans
APR: The APR or annual percentage rate reflects how much your debt would cost over a year including both interest and fees.
Loan amount: The capital borrowed. You will repay this plus interest charges on top.
Monthly repayments: A fixed sum payable each month to ensure the capital and interest are paid off at the end of the term.
Term length: How many months or years it will take to repay the loan assuming set repayments are adhered to.
Early repayment charges: A fee if you want to pay off your loan before the end of the term, normally one or two months’ interest.
Fees: A charge to set up or arrange the loan. The APR should take fees into account to make it easy to compare the total cost of different loans.
Total repayable: The total amount you will repay over the term, including interest and fees.
Eligibility: Criteria customers need to meet to be accepted for a loan.
As the name suggests, secured loans require security, or “collateral”, usually in the form of property, a motor vehicle, or another valuable item, as a guarantee for the loan. This effectively reduces the level of risk to which a lender is exposed, as the lender has a claim against your home, or other effects, if you default. Secured loans are often available at competitive interest rates. Types of secured loans include mortgages, logbook loans and some types of hire purchase where the loan is secured on the goods you’re buying and these are repossessed if you default.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.