If you want to borrow money and pay back a fixed amount every month, a personal loan is one option. Here’s what you need to think about before you borrow and how to make sure you get the best deal for you.
What is a personal loan?
Personal loans are loans that a bank or other lender makes that are not secured against any asset such as your home.
They’re also known as unsecured loans.
Personal loans – The pros
- You might be able to borrow more than with a credit card.
- They usually charge a lower rate of interest when compared to a credit card on larger balances.
- Your loan repayments will also usually be a fixed amount each month, which can make it easier to budget.
- The interest rate you pay on a personal loan is usually fixed (but not always - check that it is fixed not variable).
- You can choose how long you’d like to take to repay the loan. Remember the length of a loan will affect the amount you’re charged in interest.
- You can consolidate several debts into one personal loan, potentially reducing your monthly repayment costs. But be careful, as this might mean extending the length of the loan and so paying more overall.
Loan providers must allow you to pay back a personal loan in full before the end of the loan term, but it can come with an early repayment charge typically around one to two months’ interest. Any fees and how they’re calculated should be set out in your loan information and agreement, so you know what to expect if you repay early.
Some lenders advertise that you won’t pay an early repayment charge (ERC) or fee if you pay off your loan sooner than agreed. But it’s likely that you’ll still be charged up to two months interest on whatever sums you repaid early.
Under the Consumer Credit Directive, almost everyone who took out loans from February 2011 onwards can make partial or full early settlements of up to £8,000 a year before being hit with penalty fees.
If there’s more than a year on the loan agreement to go, once more than £8,000 has been paid off, the maximum penalty charge that can be levied is 1% of the amount being repaid early.
If that kind of overpayment is made in the final year of the credit agreement, the penalty can’t exceed 0.5%.
Ask your lender for a ‘settlement statement’ showing how much you’ll save by repaying early.
Personal loans – The cons
- Because the interest rate might reduce the more you borrow, you might be tempted to take out a bigger loan than you need.
- Most banks won’t lend less than £1,000 or for shorter than 12 months. So you might end up borrowing more than you need, or can afford.
What is a personal loan cooling-off period?
You have a 14-day cooling-off period from either the date the loan agreement is signed or when you receive a copy of the agreement, whichever is later.
If you cancel, you have up to 30 days to repay the money.
You can only be charged interest for the period you had the credit - any additional fees have to be refunded.
What to watch out for with a personal loan
You might not actually get the interest rate advertised.
You will often see the representative APR (or annual percentage rate).
Just over half of people who apply for and are given a loan should get this rate or better - but that could mean up to half pay more.
If your credit rating is less than perfect, you might be accepted for a loan but charged a much higher rate of interest.
Ask the lender for a quote before you apply.
Some personal loans have variable interest rates, meaning they can go up or down.
If you’re only just able to afford the initial repayments you should avoid this type of loan in case they do go up.
Look out for any arrangement fees, which will make a loan more expensive.
Make sure you include them when you work out how much the loan is going to cost you.
Arrangement fees will be included in the APR – which is why you should compare APRs rather than just interest rates.
If you’re already struggling to pay your bills and repay other debts, you shouldn’t take on extra debt such as a personal loan.
How to get the best personal loan deal
- Don’t just accept the first rate you are offered by your bank or building society.
- Shop around to see which providers are offering the cheapest APRs. Compare APRs (but remember that you might end up paying more if you have a poor credit history). A comparison website can help you do this.
- Ask the lender for a quote before you apply. If they have to do a credit reference check, ask if they can do a ‘quotation search’ or ‘soft search credit check’ (which does not leave a mark on your credit record) rather than an application search (which does).
- Consider peer to peer loans especially if you have a good credit rating. These loans might offer lower interest rates and are available for smaller amounts. They are featured in most comparison tables.
Check the best personal loan rates on the Which? websiteopens in new window
Secured personal loans
If you own your own home, you might be tempted to consider a secured loan. Typically the interest rate is less but the term to repay may be longer, which increases the overall interest cost.
However, this is a much riskier option as the money you borrow is secured against your home.
This means that if you can’t repay the loan, the lender could force you to sell your home to pay off what you owe.
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