There are several types of loans on the market. We’ve put together a quick breakdown to help you understand the difference between them.
Loans allow you to borrow a fixed amount of money and repay it in equal amounts over a set period of time (‘the term’), normally at a fixed interest rate.
How much you can borrow and the interest rate you’ll be charged will depend on the type of loan, your personal situation and your credit score. (You can check your credit score with ClearScore for free).
Personal loans (also known as unsecured loans)
A personal loan comes in all sorts of shapes and sizes. Personal loans are also known as unsecured loans because you don’t have to use anything as security for this type of loan (e.g. your house or car). The offer of a loan is based on the information held in your credit report, along with some personal details in your application (such as your income, which doesn’t appear on your credit report).
Personal loans can sometimes be labelled for specific purposes. For example, a ‘car loan’ is a personal loan for the purpose of buying a car. But this is just a way for lenders to market their products – it doesn’t necessarily mean it will be the best way to borrow money. If you are borrowing money for a big purchase, it’s a good idea to take the time to look at all the options.
You can normally borrow between £1,000 and £25,000 with an unsecured loan. You’ll pay an interest rate of somewhere between 3% and 30%, and you’ll have to repay the loan in one to seven years.
Lenders charge different interest rates depending on how much you want to borrow. These are known as ‘tiered interest rates’, and if you ask your lender about them, you can sometimes save money by borrowing just a few pounds more and getting up to a higher tier.
Unsecured loans usually have higher interest rates than ‘secured’ loans. This is because they are riskier for the lender – but they are less risky for you.
You can find out more in our article about personal loans.
A secured loan is money that you borrow secured against something that you own. If you don’t repay the loan, the lender has the right to take the asset you put up as security.
Most secured loans are secured on a property you own, i.e. your house. This is why secured loans are often known as ‘homeowner loans’ or ‘second mortgages’.
To take out a loan secured on your home you will need sufficient equity in the property. Equity is the difference between how much your house is worth and your outstanding mortgage.
As well as the equity in your property, lenders will also look at your borrowing history.
Secured loans tend to be used to borrow larger sums of money than personal loans. You can normally borrow between £5,000 and £100,000 with a loan secured on your home. You’ll pay an interest rate of about 4 to 10% and have up to 25 years to repay the loan.
Taking out a loan secured on your home comes with an obvious risk, as the lender has the right to repossess your house if you don’t repay the loan.
There are other types of secured loan as well those secured on your property. It is possible to secure a loan on your car, and these loans are known as ‘logbook loans’.
Another example is a ‘pawnbroker loan’. Pawnbrokers accept items such as jewellery and gadgets as security for a loan. But as these items are worth less than a house, you won’t be able to borrow a large amount of money and the interest rate could be considerably higher.
Payday loans are short-term loans designed to be paid back within 28 days – i.e. your next payday.
Payday lenders charge a fee instead of advertising an interest rate. You might pay £25 to borrow £100 for 28 days, and so repay £125.
But if you miss a payment or can’t repay the loan you’ll be charged more money. This means payday loans can work out to be quite expensive.
Want to know more? You can read our article about short term loans.
Debt consolidation loans
A debt consolidation loan is designed to help you if you’re struggling to pay a number of debts to different lenders by moving all your debt into one place.
The main benefit of a debt consolidation loan is that you will have one monthly payment to make instead of several. Depending on the interest rate, it can also lower the amount you repay each month.
A debt consolidation loan may actually just be a secured loan or an unsecured personal loan marketed for the specific purpose of moving your debt into one place.
But be careful, your monthly payment for the debt consolidation loan might be lower than your previous payments added together, but if the debt consolidation loan is repaid over a longer term it could mean you pay more interest in total.
Here’s our article all about debt consolidation loans.
'Bad credit' loans
If you have a low credit score, or don’t have a credit history at all, you may struggle to get a loan from a bank or building society.
But you could be eligible for a bad credit loan (sometimes called a ‘subprime loan’) from another lender. You’ll pay more interest with a bad credit loan and might be asked to offer security for the loan, because lenders will look at your borrowing history and judge you as ‘high risk’.
If you are in this situation you can read more about loans for poor credit for some extra tips.
There’s another option if you have a low credit score, and that’s a guarantor loan. This means you’ll need to ask someone else – the ‘guarantor’ – to agree to be responsible for paying the debt if you can’t. The guarantor will need to have a good credit history and will usually be a parent, another member of your family or your partner.
You’ll pay quite a high interest rate with a guarantor loan, normally between 40 and 50%, but if you repay it on time, your credit score will improve.
What do you need to consider when taking out a loan?
The representative APR: Advertised loan APRs are ‘typical’ or ‘representative’ rates offered to at least half of successful applicants. You’re more likely to be offered the advertised APR if you have a good credit history. You can check your credit score with ClearScore here (link).
Repayments: Can you afford the repayments for the entire length of the term? You can take out a payment protection insurance (PPI) policy to cover payments in case you’re sick or lose your job.
The term: You can pay less each month if you opt for a longer term (time period) over which to repay a loan. But the longer the repayment term, the more interest you’ll pay overall.
The loan amount: Think carefully before borrowing more money than you need as the bigger the loan amount, the greater the commitment you’re making.
Extra charges: Watch out for administration charges for setting up a loan, early redemption penalties if you are able to repay a loan early, or penalties for late payments.
Comparing loans: You can save money by shopping around for the loan which suits your needs best. ClearScore provide loan recommendations based on your credit score, for instance.
Other options: Check whether a credit card or overdraft would be a better option. You can read about the difference between loans and credit cards here