personal loans can be an affordable way to raise funds for all kinds of expenses. Uses of an unsecured loan can include financing a new car, home improvements, or even a one-time wedding or vacation.

Sometimes a loan can be the solution to consolidating expensive credit card balances and can save you money in the long run.

A Personal loan can be a cost effective solution as low interest rates mean borrowing is relatively inexpensive. Although loans are readily available commercially and online, taking one means signing a legal contract, so it is important to make sure that you understand exactly what you are agreeing to.

How does a personal loan work?

You can borrow from £ 1,000 to £ 25,000 and £ 30,000 via a personal loan, and sometimes more if you are already a customer of the bank.

However, interest rates, which are expressed as Annual Percentages (APRs), are scaled based on the amount you borrow. Typically, rates are much higher on loans under £ 7,500, so for much smaller amounts it may be a good idea to weigh other types of borrowing such as 0% credit cards or the overdrafts.

While it may seem counterintuitive, if you are considering a loan, it may even prove to be cheaper to borrow a little more than you expect.

For example, if you want to borrow £ 7,400, a loan of £ 7,500 (the threshold at which the lowest APRs come into play) might make borrowing less expensive overall. But do your math first, using an online calculator, to make sure that’s the case.

On the other end of the scale, if you want to borrow more than the maximum offered by a personal loan, you’ll need to put down collateral, like your home, and take out a secured loan instead. This is not a decision to be taken lightly because it means your home is in danger. It is also not an option for everyone – tenants for example.

You can choose the length of time you want to pay off a personal loan. Most loans range from 12 months to seven years with a fixed rate, so you know exactly what you are paying each month. Always check, as some loans may be offered at a variable interest rate that can go up and down.

As a general rule, the longer the term of the loan you choose, the lower the monthly payments will be, but the more interest you will pay overall.

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What do lenders charge?

The APRs representative of the cheapest personal loans are currently valued at less than 3%. But the offers vary over time depending on the market. Advertised APRs are also “representative”, meaning that they should only be offered to 51% of accepted applicants.

When you apply for a loan, lenders will assess your creditworthiness by checking your credit history, which will highlight any missed or late payments.

Such defaults will most likely have an impact on the interest rate offered to you if your application is accepted. So you may not get the interest rate you see advertised. If you have a history of late or missed payments, you will likely be offered a higher APR.

Your credit score will affect the approval of the loan application and the final interest rate offered. Once you have completed the application process, you will receive confirmation of the rate you will be charged.

The importance of shopping

Taking the time to think about the best loan for you and compare credit offers could save you a substantial amount of money. Don’t just go to your bank, for example, as they are unlikely to offer the lowest rate in the market.

Use a comparison site to make sure you find the cheapest rates on the market and from a supplier you trust.

Don’t do a handful of applications to pick the cheapest deal. By making multiple requests, you could damage your credit score and be forced to pay a higher rate, or even be denied credit entirely.

This is because if a lender can see that you have made a lot of loan applications, they may assume that you are in desperate need of money, preventing them from offering you a loan.

However, if you are using a eligibility checker, this will perform a “software search” instead. This means you can see how likely you are to be accepted for a personal loan before you apply, and you won’t leave any imprints on your credit report.

Once you find an affordable loan, you can apply online and sometimes the money can land in your designated bank account the same day. It all depends on the lender and how quickly your request can be processed.

Change of circumstances

As part of the loan agreement, you agree to make the indicated monthly repayments for the duration of the loan. If this seems to be getting difficult, it’s important to talk to your lender before you run out.

Not paying off a loan affects your credit score, whether you miss one or more payments. A missed payment will be marked on your credit report, which means other lenders will see that you have failed to meet a loan. This will reduce your chances of being approved for future credit cards and loans, as well as rental contracts or even a mobile phone contract.

However, if a missed payment is agreed with your loan provider – such as a pre-approved payment holiday – it will not create a default on your credit profile.

Whatever your situation, don’t bury your head in the sand. Lenders may agree to restructure the loan, agree to smaller payments for a period of time, or offer a complete disruption of payments until you get back on your feet.

Scam alert

If you decide that a personal loan is right for you, be on your guard. There is a growing scam involving personal loans that could seriously leave you out of pocket.

Fraudsters contact you out of the blue and offer you a loan. The problem is, they ask you to pay an advance to release the funds. You will likely be told that the fee is refundable and will serve as a deposit or administrative fee to secure the money. This may be as low as a few pounds, although in some cases the crooks have demanded a series of fees, totaling hundreds of pounds.

Not only will the crooks walk away with your money, but they will also regularly steal the details of your card used to make the payment. There is of course no loan at the end of it.

A genuine loan offer will never require payment to activate the loan, and if you take a loan from an unauthorized company, you will not be covered by the Financial Ombudsman Service if something goes wrong.

Compare personal loans from the best lenders

Check your eligibility for a range of loans without affecting your credit score.

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