Whether you want to take out a personal loan to get a brand-new vehicle or to cover emergency expenses, there are a number of factors that you need to take into consideration before getting one.
As with any financial product, you should be fully aware of the pros and cons, the terms involved (i.e. what’s expected of you, the borrower) and the best way of going about getting the best deal.
In this guide, we will walk you through the steps that should be taken before getting a personal loan, to help you get an idea of whether or not it is right for you and if you should get one right now.
7 things to be aware of before applying for a personal loan
1. Unsecured vs secured - Make sure you’re getting the right loan for you
When it comes to getting a loan, you need to be 100% sure that you’re getting the right personal loan for you and your financial situation.
You must also be aware of the risks involved and what’s expected of you in terms of repayments.
So, the first thing you need to understand is the difference between a secured loan and an unsecured loan.
- A secured loan means that the money you have borrowed is secured against an asset of yours - this is usually your house. If you fail to make the loan payments, the lender can repossess your home as a consequence. This is usually an option for people who have a low credit score, but it is a high-risk option at that.
- An unsecured loan is one where you borrow money from a bank or lender, but it is not secured against your home; therefore, it generally comes with less financial risks as your possessions aren’t put up as collateral.
One of the main reasons why people take out a personal loan is to consolidate their debt, meaning that they pay off all of their debt (credit cards, loans, etc.) with just the one loan repayment for a certain period of time, which can make managing debt payments far easier for those who may be struggling to manage it.
This can be risky, however, and we do not recommend that you get into more debt if you are struggling financially.
What we do recommend is getting expert advice from a debt advisor from free charities like StepChange and Citizen’s Advice. If you are struggling with your finances and are unable to keep up with your debt, they will be able to look at your individual situation and guide you on the next best step.
Debt consolidation isn’t for everybody and managing finances can seem like a minefield to consumers, so it is always worth getting expert help and advice, especially when that help is free.
Just make sure that if you do decide to take out a loan to consolidate your debt, you fully understand whether or not it is secured or unsecured, and you also need to know how you are expected to pay it back (including consequences for missed payments, etc).
2. Have a repayment plan in place
If you have decided that you want to borrow money and take out a loan, you must consider the impact it’s going to have on your finances and whether or not you really want to be in debt.
One of the most important things you need to do is work out whether or not you can truly afford the loan repayments, and the best way to go about doing this is to sit down and work out your monthly budget.
To do this, you’ll need to write down every single monthly bill you have - if you’re unsure where to start, your bank statements will help you identify your monthly bills.
Total this amount and deduct it from your monthly earnings. With the money that’s leftover after all expenses have been considered, you’ll need to set aside some money for essentials, like food and anything else you may need to buy throughout the month.
This is also a good time to identify where you may be spending unnecessarily; you’ll have to try to cut back on that if you want to take out a loan.
After all of your essential payments and bills have been considered, you'll need to look at the amount of money left over to determine whether or not it is enough to cover your potential monthly loan payment.
If it isn’t enough, or you are at all unsure about whether or not you’ll be able to afford repayments, then you should not take out a loan just yet and you should seek expert advice.
3. Is it really your cheapest option?
One main advantage of getting a personal loan is that you know where you stand in terms of the length of the loan (i.e. how long you have to pay it back) and fixed payments, which help to plan ahead and budget.
It’s important to understand, however, that a personal loan isn’t your only borrowing option and it may not be the cheapest way to lend.
For example, there are many 0% finance deals when it comes to making larger purchases, which means you can buy an item and pay it back over a certain amount of time (usually 12 months, but this can differ between lenders) without any interest - known as interest-free borrowing. This is an easier way of spreading the payment and makes borrowing more affordable, as there is no interest to add to the overall cost.
MoneySavingExpert, Martin Lewis, states that using a credit card to make a purchase and repay it within the 0% period is one of the best ways to do so.
By making regular payments with your credit card, it can help to boost your credit score, which is also an essential aspect of your finances.
Again, only do this if you can afford to make the repayments fully and on time.
4. Work out the best term for you
Generally, the longer the loan term you have, the more it’s going to cost you overall due to the added interest on top of your monthly payments.
While many people choose longer loan terms to spread the cost out further and to make the monthly payments lower, it is important to be aware that you’re essentially paying more if you do this, when you could actually be paying less.
According to MoneySuperMarket Martin Lewis, “the general rule of thumb is to borrow as little as possible, for as short a time as possible”.
So if you can, you’ll be much better off in the long-run if you borrow over a shorter period. By doing this, it will increase the monthly cost - but in the end, you will have paid much less in total.
Again, if you are going to do this to reduce the overall cost of borrowing, you must be able to afford the monthly repayments, especially if it means that a lower term will give you higher monthly repayments. If not, you will need to adjust the loan or find a different one that suits you and your budget.
5. Check your eligibility
When getting a personal loan, you will probably get it from one of the following types of providers:
- Building society
- Private lender
- Credit union
In order for a lender or creditor to give you a personal loan, they need to assess the financial history of the consumer who wants to borrow so they have the reassurance that you are definitely going to pay the money back in full and on time.
To do this, they will look at your credit history, and potentially a few other factors depending on how thorough they want to be.
Lenders can easily check your current credit score and report with credit reference agencies (CRAs) to get a good idea of your borrowing history.
Some lenders may look at just one credit reference agency (such as Experian) to get your credit score, while others may look at all CRAs to get a better picture. With Checkmyfile, you can create a free account to check your score and get a report that shows you data from all UK CRAs - that way, you know what lenders are viewing no matter what CRA they check.
By regularly checking your credit score, you know where you stand when it comes to borrowing. If your score seems quite low, you’ll need to work on building it back up so that you’re offered the best deals (people with lower scores may be refused credit or get offered deals with higher interest rates).
For more information on credit scores and what lenders look at when applying for a loan, read our full guide: Personal Loans Explained - Should I Get a Loan Now?
6. Prepare to pay on time and in full, every time
If you do get a personal loan that suits your budget, it is vital that you make every repayment on time and in full as per your agreement.
If you fail to make the repayments, it will negatively affect your credit score and your chances of borrowing again in the future will be limited.
And remember, if you have a secured loan, you risk having your house repossessed so it is not worth it in any way. Always make sure you fully understand the repercussions of failing to make payments with your provider.
7. Tricks for getting the best deal
Many people choose to take out a loan with their bank because they have been a loyal customer for years and feel that it is the best and easiest option.
However, if you really want to make sure you’re getting the best personal loan deal, it pays to spend that extra time doing your research before you jump into the first option available to you.
You will need to compare deals that are currently being offered by other banks and private lenders, which you can do by getting quotes directly from specific companies and by looking on comparison sites.
By looking at different deals and gathering a range of quotes, it helps you spot the best interest rates on the market and you can find one that suits you and your budget.
Remember: When comparing deals, be aware that the price you see may not be the true representation of what you will actually pay, as it all depends on your credit history.
What should I do next?
If you’re considering taking out a loan, but are still unsure of whether it’s for you, then we recommend that you do not do so just yet.
The next best steps you can take include doing your research and checking your credit score to see if you are eligible for a loan.
At Bobatoo, we recommend checking your score with Checkmyfile as you get a more detailed report than anywhere else online. You can find out more in our Checkmyfile review.