At some stage in our lives, many of us will use credit to make a purchase, whether it's a mortgage, a credit card, or a personal loan. Unsecured loans are one of the more popular ways to finance some of life's bigger purchases.
Perhaps you want to conduct some much needed home improvements, or maybe you need a bigger car for a growing family. Whatever your reasons, an unsecured personal loan might just be the answer.
These days, there are thousands of loans on offer and an increasingly large number of lenders to choose from. So how do you go about selecting the right loan for you and what should you look out for?
What is an unsecured loan?
Generally speaking, there are two types of personal loan: unsecured loans and secured loans. The fundamental difference between the two is that with a secured loan you agree to offer your home as security should you fail to keep up repayments on the loan. Because the borrower is offering the lender this security, you can generally borrow higher amounts than an unsecured loan, in some cases up to £100,000.
With an unsecured loan you do not offer your home as security and it's therefore a more popular form of borrowing among consumers. Unlike a credit card, the interest rate on an unsecured loan is fixed and you will therefore pay back a set amount each month until the end of the term of the loan, when it's finally paid off.
How much do you need and over what period?
Before you start looking for your loan, have a think about how much you need to borrow and over what period you would be most comfortable paying the loan back. Work out what you can afford now, as this will impact the length of time you borrow for.
How much you borrow will depend on the purpose of the loan. As a guide, personal loan amounts start from around £1,000, with £25,000 being the maximum amount you can borrow. Again repayment terms vary between lenders, but you should expect the option of repaying the loan over a period of between two and 10 years, depending on how much you borrow.
The interest rate of a personal loan tends to vary depending on how much you borrow. As a guide, the more you borrow, the lower the interest rate will be and vice versa. In some cases, lenders will offer one interest rate across all values to make it easier for consumers to understand, but these tend to be few and far between.
Make sure you compare the typical Annual Percentage Rate (APR) of a variety of lenders to find the best deal. There is a huge difference between the lowest and most highest rates on the market, so do your homework if you want to get a competitive deal. The big banks tend to be more expensive and you might find cheaper deals by going to a direct lender. However, if you're looking at loan advertising, don't just rely on the interest rate that is advertised, as more often than not, they will advertise the lowest rate in their range, which will often be for the highest amount (usually £25,000) to attract customers in.
The best way to search the market is to use the Internet. There are a host of comparison sites available that allow you to search for the best rates, based on how much you wish to borrow, and you could find the best deal for you in minutes.
How quickly will you get your money?
While the banks tend to be more expensive, if you go for a loan at the same bank you hold your current account with, you'll most likely get your money more quickly. The reason lies in the reduced administration time involved with your own bank. They have all your details already, such as your address, your account details, your income and your outgoings. This means they can approve you more quickly by cutting out more of the form filling and ID verification processes. If you were to arrange the loan in the local branch of your current account provider, you could get the money in your account on the same day.
If you go to a direct lender with whom you have no existing relationship, the process might take longer. Although many claim to get you the funds within 24 hours, this is usually after they have received your signed loan agreement, which tends to be a few days after you've applied. You might be expected to pay a fee of around £25 to get the money transferred within 24 hours, otherwise it could take around three to four working days. All in all, you should probably expect the funds to be in your account around a week after your original application.
So, if you're trying to secure that secondhand car on the forecourt before it goes to someone else, it may be quicker to go to your own bank, but expect to pay a little more for the privilege. If, however, time is less of an issue, you might get a cheaper deal by going to a direct lender.
Other considerations before you apply
There are a few other things to consider before you choose a lender and start your application.
Early repayment penalties
Some lenders will charge a fee (usually around two months' interest) should you find yourself able to pay the loan back before the end of the agreed term. There are plenty of lenders that don't charge for early settlement of the loan, so you should check before you decide to apply.
Repayment holidays are a popular feature of personal loans, with some lenders offering three monthly repayment holidays each year. Some may even allow you to defer the first three months' payments when the loan starts. This can be useful from a budgeting perspective, but be aware that what you don't pay in any payment holiday will be added to the remaining term of the loan and may increase subsequent monthly repayments.
It is standard, particularly if you apply to a lender you have no existing relationship with, for the lender to ask you for the following information as part of the application process:
- Details of where you've lived for the last three years
- Your employer details
- Your income/salary
- Your bank details (account number, sortcode, etc.)
- Your outgoings (including monthly mortgage/rent payments, living expenses, etc.)
- Any existing credit commitments (loans, credit cards, etc.)
After receiving this information, the lender will, with your permission, conduct a credit check.
Banks and lenders will conduct a credit check on anyone applying to borrow money, whether it be a credit card, personal loan or mortgage. The credit check will give them information on your payment history, including whether you have missed payments in the past, have County Court Judgements against you, or whether you have a history of being a reliable borrower. The check will also inform them of the total amount of outstanding debt you have with them or any other lender.
The questions answered in your application along with the details of your credit check, will provide the lender with your credit score. If you score well, based on their lending requirements, you will get the loan. If you fail to score highly enough, you will most likely be turned down.
You have the right to access your own credit report to see what information is held on file about you. It is advisable to look at your credit report before applying for a loan, credit card or mortgage to see if you are likely to be accepted. Every credit check you receive will be logged on your credit file, along with any rejections from lenders you receive. This will have a negative impact on any future applications you make.
Payment protection insurance
During your loan application, you may be asked if you would like to take out a payment protection policy with the loan. This product works by insuring you against accidents, sickness or unemployment and the potential loss of income from these events that may mean you are unable to repay the loan for a certain period of time. Lenders will try to sell this insurance to applicants, as it's a profitable product for the lender and often subsidises the low interest rates they offer. Remember, this cover is optional and you will not be penalised by the lender for not taking it out, so make an informed decision.
Most lenders' insurance will usually cover the cost of repayments on your behalf for up to 12 months. However, there are some circumstances where lenders will not pay out on the insurance. For example:
- If you have an existing medical condition that you knew about at the start of the application
- The insurance does not cover a particular illness you contract
- If your reason for being unemployment is because you resigned, accepted voluntary redundancy, or were fired due to your own conduct
- You should therefore read the small print carefully to find out if the cover is right for you before agreeing to any policy. The lender's insurance may not be the cheapest, too, so you might want to think about shopping around for the best deal before taking it out if you feel you want the insurance
Your loan decision
Whether you apply online, over the phone, or in person at a branch, you are likely to receive a lending decision fairly quickly. In most cases, you will receive an instant decision, straight after submitting your application, although in some cases it might take up to 24 hours. It all depends on the efficiency of the operations in place at the lender.
You will be told whether your application has been successful and what rate you will be offered.
Some lenders offer a personal interest rate depending on your credit score. In other words, applicants with the best credit score may be offered the lender's best interest rate for that amount and term. If the score is less favourable, however, you may still be offered the loan, but at a higher rate of interest to protect the lender from the greater risk you may present to them as a borrower.
While this may seem unfair on one level, it allows the lender to lend to you when another might simply turn you down. If, for example, the rate you are offered is much higher than the advertised rate or the rate you were expecting, it's likely the lender operates a risk based pricing policy.
Your loan agreement
After completing the application and having been accepted, you will need to sign your loan agreement. If you've applied direct, this will be sent out in the post and you will be asked to sign it and return it to the lender, keeping a copy for yourself. You may also be asked to send:
- A form of identification
- Proof of your address (utility bill, etc.)
- Proof of income (usually 3 months' bank statements)
These documents will be returned to you after the verification process has been completed. Most lenders will offer a cooling off period after the application has been submitted. This is often around 14 days and allows you time to consider your application and circumstances before signing the agreement and committing to the lender for the duration of the term.
Paying your loan back
Having signed your loan agreement, you have committed to repaying the agreed amount over the agreed term to the lender. If you have any difficulties in meeting your repayments, you should contact the lender at your earliest convenience to arrange a solution.