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Personal loans: a beginner's guide
The loan market is notoriously full of the sort of pernicious small print that should make the most hardened banks blush and can certainly make the cheapest loan deals more expensive than they seem.
In this guide we'll navigate that small print to find out how the savviest consumers score the best loans.
Types of loan
Personal loans are loans arranged between individuals and financial institutions such as banks and building societies.
You will be lent a lump sum of money and will arrange monthly repayments with the lender over a fixed amount of time with a fixed interest rate.
Unsecured is what we usually mean by the term personal loan: the consumer borrows an amount without bringing any of their other assets into the equation.
There is no direct link between the loan and your home, reducing risks in the event that you are unable to repay.
Credit cards and overdrafts are much more informal forms of unsecured borrowing.
Secured loans are just that, secured on something that you own, usually your home.
You should think very carefully and seek financial advice before securing a loan against your home.
The nightmare scenario is that if you are unable to meet your repayments, your home could be repossessed by the lender.
Just to clarify, however, those providers who advertise borrowing for a specific use or for homeowners generally aren't secured loan providers. The application criteria - a home, for example - is separate from the loan itself.
Why do people take secured loans?
Taking out a secured loan means that borrowers risk losing their biggest investment if they fail to repay.
That's much more difficult (though not completely unknown) in the unsecured loan sector.
So why do people choose to take out secured loans?
Two reasons: first, because these products allow consumers to borrow much larger amounts and second, because providers will take the security of the asset in lieu of a better credit history.
Given that many of those excluded from the unsecured loan market are unable to borrow because they have serious debt problems in the fairly recent past it's easy to see why this sector has such a poor reputation.
Payday lenders offer small amounts of cash, very quickly and often to people who find it hard to get credit elsewhere.
While they are often very upfront about the fees and interest they charge, usually describing it in pounds and pence, the equivalent APR of payday loans normally hits the eye-watering heights of around 2,000% APR.
This makes them suitable only for lending for very short periods of time and for people who will definitely repay. There are numerous alternatives.
Note that Choose doesn't list payday lenders, see more on our view here.
Debt consolidation loans
Debt consolidation loans (DCL) are a method of reorganising existing debts into a single monthly repayment.
DCLs are usually secured against your property and are therefore not an ideal solution as they convert multiple unsecured loans in the form of credit cards and personal loans, into a secured loan.
They often come with longer repayment terms and the total to be repaid will often be higher. For further information check out our guide here.
What is an APR?
APR is short for Annual Percentage Rate and it is used as an indicator to show how much your borrowing will cost you per year for the life of your personal loan.
APR is a useful way to make a comparison between different personal loan providers as it is a legal requirement to display APR for any personal loan products.
The representative APR is the amount that a fixed percentage of customers will pay. Currently EU law stipulates that this figure must be paid by a minimum of 51% of customers.
Interest rates for each personal loan customer will depend on a number of factors including credit history and the loan amount.
A representative APR on advertisements allows consumers to make quick and easy comparisons between different personal loan providers.
Representative APR is calculated the same way by all personal loan providers however, when comparing APR between different providers remember to compare like for like only on loans of the same amount.
A representative example showing how much you have to repay in total as well as the monthly repayments for a loan of a certain amount with a particular interest rate must be shown by law with all adverts for personal loan products.
Representative examples can give you a much better idea of how much a personal loan will cost over its life.
Bear in mind though that it is representative and that the actual circumstances of a personal loan may differ from those advertised once other factors such as credit history are taken in to account by the lender.
Applications and starting repayments
As we've discussed above, personal loan providers often publish specific application criteria. This can include home ownership and will certainly include annual salary and previous borrowing history.
When applicants don't meet, and preferably exceed, these expectations they can face rejection from lenders.
When a personal loan is approved applicants will normally be issued a cheque by post around a week after the final decision.
Some lenders offer options for quicker cash - either by transferring the money straight to a current account or by offering a courier option for the cheque - but they generally charge around £50 for that couple of days fast track.
Starting to repay
The first monthly payment on a personal loan is generally due a month after the loan is issued.
Failing to make a monthly loan repayment will incur a default payment - usually around £25 - and the missed payment will show up on credit reports.
In addition, missing a loan payment means that the cost of overall borrowing will rise as the end date of repayment is pushed back.
Setting up a direct debit can help to ensure that repayments are always made on time.
Note that making repayments early could also incur fees, see more detail here.