Personal Loans Explained - Should I Get a Loan Now?
While we are currently living through the Coronavirus pandemic, many people who are struggling financially or looking to make large payments are wondering whether or not they should get a loan right now.
In this complete guide, we explain everything you need to know about personal loans, including how they work, what you need to be eligible for one and how to go about finding the best deals on the UK market.
In this guide:
A personal loan is essentially an amount of money that’s borrowed by a UK consumer, following which they must pay it back over a period of time, usually with interest added on top.
Personal loans are provided by banks, building societies, credit unions and other private lenders, and they do not secure the loan against any assets you own, such as your house, which is why they are also known as unsecured loans.
The length of a personal loan is usually a minimum of two years, depending on the amount you’re borrowing and the lender’s terms and conditions, and prior to the end date of your loan, you are able to pay off the loan in full, make over-payments or pay off a part of the loan at any time during the contract without incurring penalties.
Some lenders may, however, charge you for repaying more than a certain amount within 12 months, so be sure to check this with your lender as they have legal limitations on charges and fees.
What is a secured loan?
A secured loan is also known as a homeowner loan, where the lender will secure your property against the amount of money you are borrowing; so, if you don’t stay up-to-date with the loan repayments, the lender could repossess your home.
For this reason, this type of loan comes with its own risks, whereas an unsecured personal loan gives you peace of mind that your home won’t be taken away from you in the event that you can’t afford payments.
Depending on your deal, however, there is likely to be other consequences for failing to make payments, so be sure you’re fully aware of these before getting the loan in the first place.
Generally, people get an unsecured loan if they want to borrow a large amount of money, but have a bad credit rating.
Learn more: Ways to Improve Your Credit Score
A secured loan does, however, puts you under more pressure as your house is essentially at-risk if you fail to make payments, so you need to consider what’s right for you and your personal situation first before diving into it.
In summary, an unsecured personal loan poses far less risks than a secured loan.
A personal loan cooling-off period is a total of 14 days from the date you signed the loan agreement (or from the moment you received a copy of the loan agreement - whatever happens last), during which you have the legal right to cancel the loan agreement without any consequences - as per the Consumer Credit Act 1974.
A lot of private lenders do not implement cooling-off periods into their contracts, so it’s always worth checking where you stand with cancelling early when taking out the agreement.
Generally, if you cancel during the 14-day cooling-off period, you have up to 30 days to repay any money you’ve borrowed - but again, be sure to check this with your chosen lender.
Personal loans vs payday loans
In comparison to a personal loan, a payday loan offers a quick, short-term - yet more expensive - solution that helps you cover any immediate outgoings that need paying until you receive your next monthly wage.
This type of loan comes with a high cost, which you need to be aware of beforehand. It often comes with very high interest rates (sometimes up to three figures!) and you usually need to pay back what you’ve borrowed within two weeks or an agreed date near your next payday.
If the borrower isn’t cautious, a payday loan can end up costing them more than they initially wanted. As with any type of loan or financial commitment, you must always ensure that you fully understand what you’re getting and how you are expected to pay it back before you agree to it.
One of the main reasons for getting a personal loan is to help cover existing debt that may be getting out of hand and causing your financial status to plummet.
You may have more than one credit card with a lot of money owing on each for example, which is likely costing you more due to interest and is impacting your credit score as a result.
You might like: 8 Reasons to Improve Your Credit Rating
In this case, a personal loan with a good APR could help as it can help you pay off your debts with just the one monthly bill to pay, making repaying your debt much less daunting and more manageable.
By having less debt repayments to make, you reduce the overall interest owed and you have the opportunity to build your credit score again (provided you make all repayments of the personal loan on time). This whole process is known as debt consolidation.
At Bobatoo, we highly recommend speaking to a debt or financial advisor before doing this, as you need to ensure you’re not putting yourself at further financial risk.
Other common reasons for getting a loan are:
- Emergencies and surprise bills - Anything can happen at any given time, whether that’s damage to your home, car repairs, a medical emergency or, most recently, the Coronavirus pandemic. Your insurance policies should already cover you for a range of circumstances (which you should be aware of), but a personal loan may come in handy if you don’t want to put everything on your credit card, which could cost you more in interest.
- Personal wishes or events - You may be looking to book an exciting holiday, arrange a wedding, purchase a luxury high-cost item, renovate your home or purchase a car, in which case a loan may offer you better interest than that of your credit card.
Learn more: What Does the Coronavirus Mean for Credit Cards?
Understandably, banks and lenders need to assess the financial risk you pose before letting you borrow money and agreeing to provide you with a loan; they need the reassurance that you’re going to pay back the money fully and on time.
To get this reassurance, they look at different factors to help determine your creditworthiness; i.e. are you financially worthy of borrowing money from them?
The main thing they will want to see is your credit score and report, as this paints a very clear picture of your borrowing history and how you’ve managed credit in the past; the higher your score, the better the chance you have of being accepted for a personal loan with competitive interest rates.
If you have a score that’s lower than ‘Excellent’ or ‘Good’, you may struggle to get a personal loan. Some lenders will reject you for credit, while others may still offer you a loan but with a higher interest rate.
To get an idea of the information seen by lenders and to stay on top of your finances, one of the best things you can do is regularly check your credit score.
Read our Checkmyfile review to see how you can get a detailed report of your credit history and score, with data from all four credit reference agencies in the UK. This helps you identify any mistakes that are potentially holding you back from increasing it.
If your lender wants to be extra vigilant, they may look at other factors to assess your financial stability before letting you get a personal loan, such as:
- Your income
- Employment history
- Financial assets (stocks, bonds, etc.)
- Student loan debt (particularly with younger borrowers)
- Home stability (how long you’ve lived in your current property)
- Your phone number (if you’ve had the same number for a long time, this shows stability)
- Professional occupancy licenses (those with an occupational licence and a high income have a better chance of being accepted compared to others)
The main thing that lenders look at is your credit score, so by regularly checking it and doing the right things to help improve, you are taking the right steps towards being accepted for a personal loans.
When considering taking out a loan, you need to assess both the pros and cons of doing so, which will give you a better idea of whether or not it is worth it for you.
Firstly, let’s take a look at the benefits and advantages of getting a personal loan:
- You can borrow a large amount of money; more than what you’re offered with a credit card.
- Personal loans usually come with lower interest rates, compared to a credit card that has a large amount of debt owing.
- The interest on a personal loan is usually fixed, so you know where you are every month - make sure you check that you’re not getting a loan with a variable rate.
- The repayments are also usually fixed - this will help you budget better.
- When taking out a personal loan, you can choose how long you want to repay the loan, whether it’s two years or five. Remember - the longer the term, the more you’re likely to pay back in interest overall.
- It gives you the chance to consolidate all your debts with just one loan one monthly payment, making it easier to manage your finances.
While there are many benefits to a personal loan, there are important things to be aware of beforehand.
Here are the potential drawbacks and disadvantages of a personal loan:
- Interest rates on personal loans tend to reduce if you’re borrowing a large amount of money, whereas the smaller the loan, the higher the interest rate will be. This may encourage you to take out a larger loan than you actually need just to avoid high interest rates.
- If you only want to borrow a small amount of money, a personal loan may not be for you, as they tend to have higher interest rates in comparison to other types of smaller borrowing, like credit cards or peer-to-peer loans, for example.
- Some banks and lenders will not provide personal loans if you require it to last for less than 12 months. They may also not allow you to borrow less than £1,000, so because of this, you may be inclined to borrow more money than you need - remember, you need to be able to afford the repayments.
- Some personal loans come with variable interest rates, which means the APR can fluctuate and may result in you paying more interest during certain months. We recommend getting a fixed APR so that you always know where you stand - unless, of course, you can afford the variable rates and don’t mind a fluctuation in cost.
- Some companies may charge arrangement fees, which makes the overall payment more expensive, so be sure to account for this when working out the total cost.
As is the same with anything, you need to shop around and gather a range of quotes from different providers to find the best deal on the market - don’t simply accept the first deal offered by your bank or building society because you’ve been with them for years.
Shop around online to see which banks or lenders are offering personal loans with the cheapest APRs and the best terms that suit you - you can do this with renowned sites like GoCompare, Compare the Market and MoneySuperMarket. Another trick is using more than one comparison site, as they all have different deals with different providers.
Remember though, the APR that you see online may not be what you actually end up with - if your credit score is below average, for example, you are more likely to have to pay a higher interest rate on top of the loan.
If you want to compare deals before committing to a loan, make sure you tell the lender that you’re looking for a quotation first, and if they ask to check your credit score, make sure they will be performing a soft credit check instead of an application check, as the latter could impact your rating.
Coronavirus pandemic: What to do if you can’t pay bills and debt - Is now a good time to get a loan?
According to the Money Advice Service:
“If you’re already struggling to pay your bills and repay other debts, you shouldn’t take on extra debt such as a personal loan.”
If you and your finances have been affected by the Covid-19 crisis, your first steps should be to contact your providers (whether that’s for everyday bills, insurance, mortgage, etc) to see what relief they can offer you - rather than looking to borrow more money. Most companies are completely understanding of the current situation and will do what they can to help ease the burden.
However, if you want to use a personal loan to consolidate your debt so that it’s more manageable for you, a loan with a lower interest rate than that of your credit card may be an option for you.
At Bobatoo, we recommend speaking to the debt experts at StepChange or Citizens Advice; they will be able to provide you with free advice on how to manage your debt based on your own individual situation. If you’re struggling to make payments, we do not recommend you take out more credit until you’ve spoken with a financial expert first.
For information on the help available for employees and self-employed workers who have been impacted by the Coronavirus outbreak, read our related guide: Can I Get Financial Help If I Am Affected By Coronavirus?
If you want to take out a personal loan but you’re unsure whether or not you’re eligible, checking your credit score is a good place to start.
By checking it with Checkmyfile, you get a full report that includes data from all four credit reference agencies - Equifax, TransUnion, Experian and Crediva. This detailed report lets you identify potential errors that could be holding you back from improving your score. They also have many useful articles on how to improve your creditworthiness and many other important things you should be aware of to stay on top of your finances.
You can sign up for your free trial by tapping the green button below. It is completely free for the first 30 days following which you will be charged £14.99 per month to be a member and make use of Checkmyfile’s services. If you don’t want to pay, just make sure you cancel before the end date of your 30-day free trial.
For further, related advice, be sure to read our useful guides below.