What Is A Personal Loan

Perhaps you’re looking at borrowing money and you’ve come across an option for a personal loan. But what is a personal loan and is it a good idea to get one?

In simple terms, it’s a specific type of loan which you can get for a specific purpose. The money you borrow must be repaid over an arranged period of time and with interest. Hence, you should read the small print and be able to make the repayments for the length of the loan, otherwise your purchase could be at risk. Sometimes a personal loan is seen as bad debt if it just builds up interest over time and you’re not using it to invest in a specific purpose. However, it can also help you to achieve a particular goal.

How Does It Work

Essentially, personal loans are a form of credit. A lender such as a bank, allows you to borrow a certain amount of money in a one time payment. For example, if you need to borrow £5,000, they might agree to give this to you as an immediate £5,000 payment.

However, you must repay the loan and interest on it on a monthly basis.  Furthermore, some lenders may charge an arrangement fee to put the loan in place as well as interest, so it’s worth looking out for this when you compare your options.

APR Rates Explained

This is where you need to do your own research and comparisons. Personal loan rates will vary according to the amount you borrow and your circumstances.

Let’s look at three examples with the same scenario.

You would like to borrow £5,000 to make some home improvements, and pay it back over a period of 5 years.

Tesco

Tesco offer a minimum rate of 2.9% APR which can go significantly higher depending on your circumstances.

If you borrow £5,000 now in 2021 and pay it off over 5 years, the offer is 3.5% which means you will end up paying back £5,449.80.

Sainsbury

For the same scenario, Sainsbury offer an APR rate of 3.3%. Which means that you will pay back £5, 424. But if you’re not a Nectar member, it increases to £5,437.

Virgin Money

Once again, for the same scenario, Virgin Money offer an APR rate of 3.4%. So you’ll pay back £5,437.64.

It goes without saying that if you want to borrow a much larger amount, your interest will also be bigger. So if you borrow a personal loan of £25,000, after 5 years you will owe £26,928.24 if you use Virgin Money. That’s interest of £1,928.24.

What You Need

If you would like to borrow money on a person loan, what criteria do you need to apply for one?

Credit Rating

Your financial history is on file. Credit agencies hold a certain amount of data on every citizen in the UK. There are three main credit rating agencies in the UK that hold information on you which is then used to determine whether or not you can borrow money or not. These include: Experian, Equifax and Callcredit.

If a lender is going to give you money, they want to make sure you can pay it back. Hence you usually need to have a good credit rating before you begin.

Financial Documents

Lenders may ask to see your proof of identification and even of salary or letters from employers. If you’re self employed, they may ask to see your tax returns and other evidence of income. They will also want proof of your address by seeing a bill or bank statement.

When a lender has looked at all this information, they might refuse to loan you the money. In which case, you can still apply to other lenders who may have different criteria. What this means is that you can keep trying if one lender turns down your request.

What If I Have A Bad Credit Rating?

If you have a bad credit rating, it doesn’t mean lenders won’t want to lend you money. But under these circumstances, the rates will usually be much higher to make up for the risk that they take. Hence you must always check the APR rate and if you can afford to make the repayments on it.

With a bad credit rating, it’s more difficult to borrow the amount of money you might need. Therefore, you may have to opt for a smaller loan.

Secured And Unsecured Loans

A secured loan requires the borrower to offer collateral against the loan, such as your home or car. It means that the interest rates are often lower than unsecured loans. This is because you have agreed to put your possessions at risk if you can’t repay the loan.

Whereas an unsecured loan is one where you do not offer any collateral or other security to use as a guarantee for the loan. Hence the interest rates are often higher which means you have to pay more money for the loan in the long run.

Should I Go Ahead And Borrow Money

In conclusion, whether or not you get a personal loan really depends on why you want to borrow the money and if you can afford to repay it.

For example, if you want to make some home improvements and you have a good credit rating, then it’s likely you will get a loan.

Perhaps you have a major life event coming up such as a wedding. A personal loan will help you to pay for the multiple purchases for the special day. Then, you could pay it off over a period of time that suits you.

However, if you’re considering a personal loan to clear debt, there could be more sensible options for you. Before adding to your debt, seek advice from a debt counsellor or charity to talk through your options. Getting a personal loan on top of other debt could put you in a worse position.

If you have a bad credit rating and you still think a personal loan is the right option for you, then make sure you check the APR rate and repayment schedule carefully. Ultimately, you must be able to afford the repayments.