Understanding Personal Loans

A personal loan is any unsecured loan credit that a lender or bank gives you. This means that it’s not guaranteed with a house, car, or other collateral. Because of this the interest rates are higher than a secured loan, but not as high as credit card borrowing. For example, if you had to choose between a secured loan, a personal loan, or a credit card cash advance, the personal loan would have the middle interest rate, with a secured loan being the lowest and a credit card cash advance being the highest.

The key reason to choose a personal loan over a credit card loan is that you’ll pay less interest and have longer to pay it back. On the other hand, the reason to choose a personal loan over a secured loan is that you aren’t using any personal security for the loan. However, you will pay more interest and not have as long to pay it back. These are important considerations that should not be overlooked when comparing loans and trying to decide which one is the best for you and your unique circumstances. You’ll want to be financially literate when looking over these terms to make sure you understand them all.

Here is a list of things to consider that will help you decide if a personal loan is right for you:

Why Personal Loans Are Good:

1. If you have good credit, you will usually be able to borrow more than you could with a credit card.

2. Interest rates are usually (but not always) fixed for personal loans, making it easier to calculate the total cost of your loan.

3. Most of the time repayments will be set to a fixed amount, meaning that you can budget for the same payment every month.

4. You are able to choose how long you would like the loan to be, depending on the lender and their criteria. This means you can stretch it out over a longer period of time to have a lower monthly payment (though that will sometimes mean you are paying more interest over time).

5. Other personal debts can be consolidated into one loan with a personal loan, meaning one low payment can cover everything.

Note: If you choose to take out a personal loan for debt consolidation, you will need to remember that in most cases you can’t repay more than £8,000 in any period of 12-months. If you do, then the lender is allowed to charge you compensation fees (these are limited by law though, depending on your loan amount). Otherwise you should be able to pay off the loan at any time without penalty (in the case of loans that are less than £8,000, for example).

Why Personal Loans Are Bad:

1. You will pay more interest than secured loans, and in particular you will pay considerably more interest for smaller loans, such as £1,000, as opposed to a larger £5,000 loan.

2. The more you borrow, the lower your overall interest rate will be. This can often cause people to take out larger loans. In these cases, they become ‘cash rich’ and spend unnecessarily. This is a waste of money, and a trap that many well-meaning borrowers fall into.

3. In the unlikely event you still have an older personal loan, or even an old loan scheme that you’ve extended by adding new amounts to, from before 1st February 2011, then you will likely have early repayment fees attached if you overpay or try to pay it off early.

4. You may not receive the advertised interest rate (known as the representative APR). This is what you see in advertisements, or posted on bank and lender websites. In reality, the rates are much higher than what you see. While banks are required by law to offer those advertised rates to 51pc of borrowers, the devil is in the details. They only need to offer that rate to ‘qualified’ borrowers. That means that in most cases, unless your credit is perfect, you won’t qualify for that rate. Always check the APR.

5. Your application for a personal loan will show up on your credit report for up to one year, even if it is not approved. You are also not guaranteed to get the loan, unlike a credit card, where you know exactly how much you can get and you’re already approved.

Personal Loans Can Be Dropped

Few people know about this, but a personal loan can be dropped if you change your mind. For example, you have 14 days from the time you sign the loan paperwork or receive your copy of the agreement (which ever comes later). During this period you can elect to cancel the loan. If you do that you have 30 days to repay both the interest and loan amount back to the lender. If you find yourself in a pinch for cash, and need to borrow some money for just a few days or a couple of weeks, this is one way to get that cash, and then repay it right away to avoid interest concerns.

Things To Look Our For

1. Certain loans will have variable interest rates. While this is not usually a problem, it can be if you are just barely able to meet your minimum payment obligation. If the interest goes up, you won’t be able to afford the loan.

2. Make sure you are not paying loan arrangement fees. These will cause the cost of your loan to be more – in some cases significantly more. This is why you should always check the loan APR in addition to the advertised interest rates.

3. Most of the time Payment Protection Insurance is not necessary. This means you do not need PPI. Even if you feel that you must have PPI, you will probably get a much better deal somewhere other than your bank. Just make sure you read the fine print. Not all PPI is the same, and some of it will do nothing to protect you – despite what a salesperson may tell you.

Keep these things in mind when loan shopping, and make sure to check with more than one lender. Don’t apply to them all though. Rather, show them your credit score, and have them run a soft check with the credit reference agencies to see what the best deal is they can get for you. If they are offering something great, with a low APR, then you should definitely consider it. Also let other lenders know, and see if they’ll match or lower their own rates. Sometimes you can get a very good deal and save thousands in interest fees.