The many faces of personal loans, but which is right for you?
24.06.2019 by Jack H
Choose the right loan for you
Loans are accepted every day for a wide variety of reasons for people from every walk of life, but not all loans are the same. There are several different types of loan with varying terms of repayment, different rates of interest and not all loans are available to everyone. Choosing the right loan for your situation could open the door to the next stage of your life or, at the very least, make a difference in your quality of life. However, it’s a decision which needs to be made with caution as the wrong choice could cause you serious financial problems in the future. If you’re confused about all the different types of loans which are available and unsure which is right for you, this guide will help you understand the differences.
In very simple terms, all loans provide you with a sum of money which you pay back through instalments over a pre-agreed period of time. Most loans are fixed period loans; for example, you need to have repaid the loan in full by a specific date, whereas a line of credit such as an overdraft or credit card can be indefinite. The money you borrow will accrue interest, which you will also need to pay; this is known as the Annual Percentage Rate (APR).
Here are the different types of personal loans you need to consider including some of the important terminology you need to be familiar with.
There are two main groups of personal loans: fixed interest rate and variable interest rate. In most cases, variable interest is applied to a revolving line of credit like a credit card, while traditional loans have fixed interest rates. Regardless of which you choose, make sure you understand the interest rates attached to the loan are and how much you will be paying back overall.
What is a variable rate loan?
A variable rate loan is so called because the interest you pay will vary over time. The interest rate is set by the banks and is likely to rise and fall to some degree during your loan period, so the interest rate you pay when you take the loan out may not be the same the following month. Variable rate loans are often advertised with a lower APR than fixed-rate loans as they are prone to fluctuation, but some may include a cap which limits how much your interest rate can change during the loan. These loans are often better for shorter repayment term as interest rates are unlikely to change dramatically in the short term.
What is a fixed-rate loan?
The majority of personal loans are fixed rate, meaning the interest rate you pay will not change during the loan period. These loans are sometimes called instalment loans as your monthly payments (instalments) are consistent. For people who want predictability and consistency over a longer term, a fixed-rate loan is often the preferred option as you don’t have to worry about the payment amount changing month to month.
Note about APR: Advertised loan APRs are often ‘typical’ or ‘representative’ rates. This means that they are offered to at least 50% of successful applicants, but these rates are for people with good credit scores. The APR you are offered may vary depending on your situation.
Common types of variable or fixed-rate loans
What is a secured loan?
If you choose to take out a secured loan, you will be putting something up as collateral to limit the lender’s risk. This means that if you fail to repay the loan, the lender is entitled to seize the collateral by way of payment. In most cases, the collateral is a house (mortgages or homeowner loans) or a title to a car (car loans or logbook loans). Some lenders will enable you to take a loan out using your savings, jewellery or other assets.
The interest rates are often lower on secured loans because the lender has the security of the collateral, the amount of the loan is larger and the repayment periods are typically longer. These loans can enable people with a poor credit score to borrow as the collateral may mean they are perceived as a lower risk by the lender. On the other hand, taking out a secure loan carries a higher risk for the borrower as your house, car, or other property could be lost if you fail to make your payments.
What is an unsecured loan?
An unsecured loan is not tied to any collateral and as such is a higher risk loan for the lender. This increased risk can mean that you usually need a medium to good credit score to be granted the loan, repayment terms may be shorter (3-5 years) and interest rates may be slightly higher than a secured loan. However, unsecured loans can offer more flexibility in terms of how much money you want to borrow and some lenders won’t ask for repayments until the 2nd or 3rd month of the repayment term.
What is a Guarantor loan?
For people who have a poor credit rating or are just starting out in the financial world, a guarantor loan could be a suitable option. You would apply for a loan with a guarantor supporting your application. A guarantor is someone who has good credit history and guarantees to make the repayments if you cannot. The guarantor should be someone close to you, and often family members fulfil the role to help young people build their own credit score. These loans aren’t tied to any collateral and usually have lower interest rates than payday loans.
What is a Debt consolidation loan
These loans can be ideal for people who are struggling to meet repayments on several different loans and lines of credit. By taking out a loan with a low-interest rate which enables you to repay all your other debts, you can save yourself a significant amount of money in reduced interest payments. Many people find this a much simpler way to manage their debts as they only need to make one monthly repayment. If the loan is fixed term, it also gives great peace of mind to have a date by which all the debts will be repaid.
What is a Payday loan
A payday loan is an unsecured, short-term loan which the borrower is supposed to repay in full on their next payday, plus any interest accrued. These loans tend to be given in small amounts of a few hundred pounds or less but have very high interest rates (sometimes in triple figures). It can make them very risky because if the borrower can’t repay in full on their next payday, the amount owed can spiral quickly. If used sensibly, these loans can enable people to bridge a temporary gap in their finances or for emergency purchases, but this should always be done with caution.
What is a Pawnshop loan
A pawnshop loan is similar to a payday loan in that they are usually smaller amounts of money borrowed over a shorter period, but these are secured loans. Your debt is tied to something you own and leave with the pawnshop such as electronics or jewellery. If you don’t repay the loan, the pawnshop is entitled to sell your possession to cover their loss. Like payday loans, interest rates for pawnshop loans can also be very high.
What is a Bridging loan
Bridge loans are short term loans which are given to bridge a temporary gap in your finances. For example, during a house purchase, you may have payments to make before your own house sale has cleared, and a bridge loan would plug the hole. These loans often have high interest rates because they are offered for short periods.
What is a Top-up loan
If you already have a personal loan and have a good repayment history but need to borrow more, a top-up loan from the same lender could be the answer as they tend to have lower interest rates than getting a brand new loan.
What is a Logbook Loan
A logbook loan is a loan secured against your car. Often one of the biggest assets people have after their home is their car. This old style loan has been around for a long while and hasn’t had the best reputation, while you will still find them available the more modern “vehicle equity release” style loan that uses a Hire Purchase Agreement is a fairer and safer alternative, and is taking over from the old fashioned logbook loan. These loans are good for people who may have trouble getting through credit checks but are still able to afford their repayments. Surprisingly easy and fast to get they can be a good solution for people who need cash fast.
Other types of loan or credit worth a mention
• A personal line of credit
A personal line of credit is also known as revolving credit and acts more like a credit card than a loan. You don’t receive a lump sum, but instead, you have access to a line of credit which you can use as you need to. This works best for people who have ongoing expenses or need to cover unexpected costs occasionally as you only pay interest on what you use.
• Credit card cash advance
If you have a credit card or are considering getting one, you may be able to use it to withdraw cash. Doing so is much like taking money out on a debit card from your bank account, but you will need to repay what you use plus interest, so this is not usually recommended for a large sum of money.
Which loan is right for you?
It’s clear that there is plenty of choices when it comes to choosing a personal loan, but finding the right solution for your financial situation needs careful consideration. There are some key questions to ask yourself and factors to consider before committing to any financial agreement.
• Can you realistically afford to make all the repayments for the length of the agreement? If you are concerned about this, payment protection insurance (PPI) policies can be taken out to cover a change in circumstances such as sickness or unemployment.
• The advertised APR is not offered to all applicants.
• Longer term loans will have lower instalments, but you will pay more in interest.
• Only borrow what you absolutely need to in order to minimise your risk and how much interest you’ll pay.
• There may be administration charges for setting up the loan, penalties for making late payments and even a fee if you wish to pay back the loan early.
Finally, to ensure you’re getting the best deal on a personal loan, it’s important to compare several options and different lenders. Don’t commit to anything you aren’t comfortable with and remember to consider potential changes in circumstances when budgeting for repayments.