What is a Personal Loan?

Have you ever wanted to borrow money but you haven't been sure how to do it? A personal loan might be the answer.

A personal loan is a way of borrowing money from a lender. Personal loans can last anywhere from one year to around 15 years, although there is some leeway in loan length, depending on the lender and their terms. There are different types of personal loans and different reasons for getting them. You can apply for a loan from a range of lenders, such as a bank, building society, or credit union. We're going to cover those variations for you here, so you can work out if this way of getting credit is right for you. If you want to know what is a personal loan, we have the answers.

Personal loans are unsecured

This means your loan won't be backed by collateral. A secured loan is secured on something of value, i.e. your home. Personal loans don't work like this. Instead, you take out a loan and pay it back to the lender via a monthly payment on that loan. Of course, you still need to ensure you meet the terms of the loan and repay the correct amount on time every month. Hence why we recommend going through your finances before applying for anything. This will help you work out whether you can meet the repayments.

However, you need to be aware that if you do not make every monthly payment on your loan, the lender has the right to pursue you for their money. They could take you to court to repay the credit they loaned you. Make sure you assess your financial situation before applying and only borrow the amount you need - no more. Don't get yourself into debt.

Since the loan is unsecured, you won't pay lower interest than you would for a secured loan. However, if you don't have any collateral or you only need a smaller amount of financial credit, this type of personal loan might be worth considering.

What can you use a personal loan for?

People tend to use personal loans for different personal reasons, hence the name. However, the personal loans work in the same way, giving an individual a lump sum of credit they can repay over an agreed period with monthly payments.

Here are some of the most popular ways to use personal loans:

1. Home improvements
2. Wedding costs
3. Consolidating credit card debt
4. Covering an emergency home purchase

If you are currently managing multiple payments on various loans or credit card balances, the total amount you might repay by consolidating those credit sources into a personal loan may be less than if you continued as you are. It means you have one payment on the total debt covered by a personal loan.

However, you shouldn't apply for a personal loan until you have worked out some calculations. Look at the rate on each loan you currently have. Look at the APR for any new deal you can find. Any financial product should be considered in depth before you apply. A lower interest rate could help reduce your overall monthly payment.

Whatever you want to borrow, and whatever the reason is for doing so, try and borrow the minimum amount you possibly can. Don't overstretch yourself as you will be paying back the loan every month for at least a year and possibly much longer. You must be sure the product you choose is right for you, otherwise, you could run into problems. You'll pay less in interest if you can pay off the loan faster. However, the monthly payments will be larger. Work out how much you could repay monthly and go below that to give yourself a cushion of sorts. Another reason why it is sensible to spend a while going through some figures. You could use a loan calculator to help you crunch some of those numbers too.

Is a personal loan better than a credit card?

If you already have a credit card, you may wonder whether a personal loan might be better. Credit cards are ideal to use for day-to-day purchases. However, they often incur a high interest rate. If you use credit cards daily and pay them off in full each month, they work well as a line of credit. However, if you do not pay off the credit cards each month, you'll end up paying far higher interest rates than you would if you had a personal loan. Anything bought on a card would therefore end up costing a lot more in the long run.

Credit cards have their place. However, if you want to buy something larger or need to consolidate your current debts to generate a lower and more affordable monthly payment, a personal loan could be a better option to think about. If you compare even a few deals for each product, you'll see that loan rates are far lower and more competitive. Even if you already have plastic that you could use for a purchase, it may not be the best solution.

What you need to know before you apply for a personal loan

If you would like to borrow an amount of money from a lender, unsecured loans may be worth looking at. The rate may well be higher for unsecured loans compared to secured ones, but you can still shop around for decent loan rates. Interest is also typically lower than that on a credit card.

Think about fixed and variable interest rates

Variable interest rate deals are typically lower than fixed rates. However, a fixed rate offer to borrow money from a lender does give you peace of mind and certainty. You know you'll need to make the same payment to the lender or bank each month. No matter how many years or how much time goes by, your fixed monthly amount stays the same.

Variable rates are just that - variable. They can go down if interest rates fall, but they can also go up. If you want certainty in your financial situation, you may think it is better to apply for a fixed offer. Variable loans may give you less to pay each month to start with, but if the lender increases the percentage payable on your loan, that could quickly change. Make sure you are clear on this and the effect it could have on the debt before you apply to get a loan.  

Consider your credit score

If you make a formal loan application, lenders will check your credit history. Lenders want to see that you have a good track record of paying back what you owe. This could be a regular monthly payment on a credit card or other loan. However, you shouldn't have too much existing debt before applying for a personal loan. If lenders think you already have too much money to pay back to other sources, they could refuse you when you apply to get a loan.

Do you need a solid credit report?

The better your credit report, the more likely you are to be able to borrow the money you need. It may be worth taking the time to check your credit rating prior to applying. There could be errors in it that you can get corrected. Experian is one of the most famous agencies carrying information on individuals and their credit history. Make sure they have the right info to start with.

However, there is a chance you could still borrow money even if your history isn't as good as it could be. Some lenders specialise in offering personal loans to people with a lower credit score. They may not accept everyone, but if your credit score has suffered, they may still accept you for one of their personal loans.

One of the most important things to remember in this scenario is that the interest rate could well be higher than it would be if you had a better credit score. Lenders offer different interest rates to individuals with different credit scores. Those with better credit scores may receive better credit offers. Consider whether you could work toward improving your score before applying for unsecured loans.

Can you repay a loan early?

Is it possible to pay off your loan ahead of time and before the official end date? It can be, but it depends on the terms of the loan you take out. Always check and read the terms and conditions in full before borrowing with any personal loan. Always ensure you can repay the loan early if you wish, and if so, that you won't be charged any fees on the total debt amount repaid. This is the best way to know upfront whether it is possible to do this when borrowing from a specific lender.

What is a personal loan and is it right for you?

You now know how a personal loan works and whether personal loans might suit your circumstances. If you do not own your home, a personal loan could be the best way to get some money for various purposes. This could be to redecorate your home, find the best solution to debt held elsewhere, or to reduce the overall interest amount you are paying each month.

Whether you look for an offer via a bank or another lender, we may be able to help. Spend some time reading about our free service, designed to help you see if you can find lenders offering personal loans to people like you. We hope you've found our guide on personal loans useful, and that we have been able to help you check the available options in this area.