You can meet a short or medium-term financial need with the help of a personal loan. These loans are an unsecured form of credit that allows you to borrow a sizeable sum of money quickly and repay it in fixed monthly instalments until the loan is paid off.

Personal loans are also referred to as unsecured loans because they are not secured by an asset, such as the borrower’s home.

Definition of Personal Loan

A personal loan allows you to borrow a specific amount of money and repay it in equal monthly instalments over a set period. The loan is paid to you as a lump sum, which you can use for purposes such as home improvements, buying a car, or paying off higher-interest debts.

If your application is approved, you can take out a personal loan from a bank or other lender.

However, it’s important to understand how personal loans work and the fees associated with them before applying. By doing so, you can make a more informed choice and avoid unforeseen charges in the future.

How Does a Personal Loan Work?

Personal loans work in a similar way to other types of loans. Typically, you take out a set amount that is repaid in agreed-upon monthly instalments over the loan term. In most cases, the interest rate is fixed.

You apply for a loan from a lender, who then assesses whether you qualify. Each repayment covers a portion of the capital and interest. If you make the repayments as set out in your contract, the loan will be fully repaid by the end of the term.

Benefits and Drawbacks of Personal Loans

Personal loans can be useful when you need to meet a financial commitment without putting your assets at risk. They are generally convenient to borrow. However, personal loans also have some limitations, so it’s important to weigh the pros and cons before making a decision.

Let’s explore the benefits and drawbacks of borrowing a personal loan.

Benefits of Personal Loans

Using a personal loan wisely can offer several benefits, some of which are outlined below:

• Repayments usually stay the same throughout the loan term, which can make budgeting easier.
• When applying for a personal loan, you can choose the loan term, which is typically between one and seven years. A longer term can reduce your monthly repayments, but you will pay more interest overall.
• Personal loan APRs can be competitive if you have a strong credit score.
• You can usually borrow more with a personal loan than with a credit card, which can be helpful for home improvements or other larger expenses.
• Some lenders may offer payment holidays, which allow you to pause repayments temporarily if you are unable to pay. However, interest will usually continue to accrue during this period, and the loan term may be extended, so it’s important to consider this carefully.
• A personal loan can be used to consolidate multiple debts into a single monthly repayment, potentially saving money if the new loan has a lower interest rate.
• As personal loans are unsecured, you do not need to provide collateral such as your home.

Drawbacks of Personal Loans

Personal loans also have certain drawbacks, outlined below:

• Interest rates can be less favourable if you only need to borrow £2,000 to £3,000 compared to borrowing £8,500 or more. This can tempt you to borrow more money than you need or can afford to repay. It’s important to assess your needs and repayment ability before borrowing.
• Because personal loan repayments are fixed, unlike the flexible repayments on credit cards, you need to be confident that you can afford the monthly payments.
• At least 51% of approved loan applicants will receive the advertised annual percentage rate (APR), while the remaining 49% may be offered a higher rate. Borrowers with lower credit scores are typically offered higher rates, while the most competitive rates are usually available to those with strong credit profiles.
• Some lenders may charge an early repayment fee if you repay your loan ahead of schedule. This fee can be equivalent to one or two months’ interest, although the exact amount varies between lenders.
• Unlike some credit cards, personal loans do not offer 0% interest periods, meaning interest is charged from the start.

There are different loan types, each with its own risks and advantages, so it’s important to understand your options before applying.

Let us help you understand the different types of loans so you can make an informed decision.

Secured Loans

These loans require collateral, usually an asset such as your home, so if you are unable to make your repayments, you risk losing that asset. A secured loan may still be appropriate if you are confident you can make repayments on time. Even with a lower credit score, you may be able to access better rates or larger loan amounts because the collateral reduces the lender’s risk. Secured loans can also allow you to borrow a larger sum of money.

Unsecured Personal Loans

You can take out unsecured loans, commonly known as personal loans, from a lender or a bank. You agree to make regular payments over a set period until the loan, plus interest, is fully repaid. Unsecured loans are not backed by an asset such as your home, which is why their interest rates are generally higher than those of secured loans. However, if you have a good credit score, you may be able to secure a personal loan at a lower interest rate.

Personal loans can be useful if you want to borrow money for purposes such as debt consolidation, buying a new car, paying for a wedding, or funding home improvements like a new kitchen.

There are various types of unsecured personal loans available depending on your financial needs. Let’s explore them.

Debt Consolidation Loans

With a debt consolidation loan, you can combine all your outstanding debts into a single loan. This involves adding up all the debt that you owe and taking out a loan to cover that amount.

Making a single monthly payment instead of several to different lenders can simplify your finances and may reduce your overall costs. However, it’s important to be comfortable with the loan term, as it could mean repaying your debt over a longer period of time.

Home Improvement Loans

Home improvement loans are essentially regular loans that can be used to pay for repairs, renovations, additions, or other upgrades to your home.

You could use a home improvement loan for:

• Converting a loft
• Adding an extension
• Remodelling a room
• Building a conservatory
• Installing a new kitchen or bathroom
• Making energy-efficient upgrades, such as double glazing or insulation

A home improvement loan can help cover the cost of labour and materials needed for your planned renovations, regardless of whether the project is large or small.

Wedding Loans

Simply put, it is a personal loan that you can take out to help manage the costs of your wedding. You borrow an amount from a lender and repay it in instalments. It can be a good way to have your dream wedding without putting too much strain on your finances.

Holiday Loans

A holiday loan is a type of personal loan designed to help cover the cost of a holiday. Taking out a loan for a holiday can help with upfront expenses and make planning easier. You repay the loan according to an agreed repayment plan at either a fixed or variable interest rate. This can make it easier to budget and manage your finances with greater confidence.

Car Loans

A car loan can be used to purchase a new or used vehicle. While car loans are often unsecured, some lenders may choose to use the vehicle as collateral. Taking out a loan allows you to spread the cost of the vehicle over a number of monthly repayments, usually at a fixed interest rate.

The loan agreement is with the lender and is separate from the dealership or seller you choose to buy the car from. You can use the loan to cover the full cost of the vehicle or just part of it.

The cost of the loan will depend on your income and credit score, with borrowers who have strong credit histories typically offered the lowest interest rates.

Applying for a personal loan online is generally simple and straightforward. If you are considering taking out a personal loan, it’s important to understand the eligibility criteria, the application process, and the credit score requirements, among other factors.

Let’s go through each of these in detail.

Eligibility Criteria

Before applying for a personal loan, you should make sure you meet the basic requirements. To qualify, you must be over 18 and a UK resident, which are the minimum eligibility criteria set by most lenders and financial institutions.

Lenders will also assess additional factors, most notably your credit history, existing debts, and income, to determine whether you meet their requirements.

Required Documents

Lenders will ask you to provide documents that confirm your residency. Each lender may have its own list of acceptable documents. However, some commonly accepted forms of proof of address include:

• Driving licence
• Benefits entitlement letter (if applicable)
• A recent utility bill
• A recent bank, building society, or UK credit union statement
• HMRC tax notification
• A recent tenancy agreement issued by a solicitor, housing association, or local council
• A local authority council tax bill for the current year

Furthermore, lenders will need documents that prove your identity. The required documents may vary by lender, and you may be asked to provide the following:

• Driving license
• Passport
• Biometric Residence Permit

To assess the risk of lending to you, lenders will review your credit history and credit score. Your credit score can affect:

• Whether you qualify for a loan
• The maximum amount you can borrow
• The interest rate you are offered

Generally, the higher your credit score, the greater your chances of receiving a loan offer and securing a lower interest rate.

In the UK, lenders typically use three main credit reference agencies: Experian, Equifax, and TransUnion. These agencies assess your credit profile using information from a range of sources, including current and previous lenders, utility providers, and certain publicly available records. This may include how long you have lived at your current address and whether you have had difficulty making repayments in the past.

Lenders usually carry out a soft credit check at the initial stage of your application. If you choose to proceed, a hard credit check will then be performed to confirm your details and determine the interest rate you are offered.

Income and Employment Verification

Credit reference agencies can sometimes verify your income through current account turnover. However, in some cases, you may still be required to provide additional documentation, such as:

• Pay stubs
• Bank statements
• Tax returns from the previous two years, or other evidence of income if you are self-employed

Lenders may also ask you to provide employment details. That said, they do not always contact your employer directly. In most cases, pay stubs and current account information are sufficient to meet employment verification requirements. If further confirmation is needed, the lender may contact your employer directly.

Application Process

You can apply for a loan in person at a local branch, over the phone, by post, or online. Not all lenders offer every application method, so it’s important to check what options are available before applying.

If you apply online, additional security checks are required. Always make sure the website address begins with “https://”. The “s” indicates that your personal information is encrypted and protected while being transmitted.

The application process is broadly the same regardless of how you apply.

• You will be asked to complete an application form with details about the loan you are seeking, as well as your personal, contact, and employment information. This also authorises the lender to carry out a credit check.
• The lender will assess your application by reviewing your credit history to evaluate the risk of lending to you. This assessment is used to decide whether to approve the loan, what interest rate to offer, and to confirm your address details and screen for potential fraud.
• The lender will then decide whether to make you an offer and on what terms. The interest rate offered may differ from the representative APR shown, as it depends on your individual circumstances.
• You can then choose whether to accept or decline the offer.

When you take out a loan from a lender, bank, or other financial institution, you agree to repay it over a set period at an interest rate.

Let’s take a closer look at how interest rates are applied to personal loans and how repayment terms work.

Understanding Interest Rates

Interest is the cost of borrowing money and is usually expressed as an annual percentage of the loan amount, or the amount borrowed on a credit card.

Interest rates are different from the Annual Percentage Rate (APR). The interest rate a lender or other financial institution charges depends on several factors, including your credit score, credit history, and existing debts.

The interest rate is set by the lender after reviewing your application and carrying out a credit check.

To better understand the overall cost of borrowing, let’s take a closer look at how the Annual Percentage Rate (APR) works.

APR (Annual Percentage Rate)

The annual percentage rate (APR) reflects the overall cost of borrowing. It takes into account both the interest rate and any additional charges applied to the loan. Before you enter into a credit agreement, lenders are required to disclose the APR to you.

The advertised rate that at least 51% of approved applicants receive is known as the representative APR. This means that up to 49% of approved borrowers may not qualify for the advertised rate and could pay a higher APR.

Fixed and Variable Interest Rate

With a fixed interest rate loan, the interest rate you sign up for at the start of the loan remains the same throughout the loan term. This means you pay a fixed amount each month. However, with a variable interest rate loan, the interest rate can change during the loan term, which means you may end up paying more or less compared to a fixed interest rate loan.

Repayment Terms

The repayment period for a personal loan generally ranges from three to seven years. However, some lenders may offer repayment periods that are slightly shorter or longer.

Check with your lender when deciding on the loan repayment term. The longer the repayment period, the more interest you will pay overall, even though your monthly repayments will be lower.

Early Repayment and Prepayment Penalties

Early repayment, sometimes referred to as resettlement, means paying off your loan before the end of the credit agreement. Depending on your loan terms, you may be able to repay all or part of the loan early.

Your loan agreement will set out any charges or penalties that apply if you choose to repay the loan early.

Early repayment fees are intended to compensate the lender for some of the interest that would otherwise have been paid over the full loan term.

The amount you borrow depends on your financial needs. However, there are a few things to consider when deciding both the loan amount and the repayment period.

Determining the Loan Amount

While the loan amounts offered vary between lenders, personal loans typically range from £1,000 to £35,000. The amount you are eligible to borrow may also be influenced by the loan term, your ability to repay, and your past financial management.

Several other factors, including your credit history and overall financial background, will also affect how much you can borrow. Lenders often give preference to applicants with stronger credit profiles, and credit reference agencies in the UK assign individuals different credit scores to help inform these decisions.

If you are a homeowner and need to borrow more than you are offered, you may want to consider a secured loan, which uses your home as collateral.

Loan Duration Options

The majority of lenders that offer unsecured personal loans provide a set amount of money at an agreed interest rate, to be repaid over a specified period. The repayment term may range from 1 to 30 years.

The longer the loan term, the more interest you will pay over time. Make sure the monthly repayments are affordable so that you do not fall behind.

Loan Affordability Assessment

When you apply for a loan, the lender will carry out an affordability check to assess whether you can afford to repay it. All lenders are responsible for making sure the loan amount and terms offered are appropriate for your individual circumstances.

An affordability check must be completed before a loan is approved to help ensure you can manage the repayments. Without this, you could end up with an unaffordable loan or one that’s larger than you need.

To assess affordability, responsible lenders will ask about your income and regular living expenses. This includes reviewing your income alongside your outgoings, such as bills and other ongoing commitments.

By assessing your remaining income, lenders can determine how much you can realistically afford to repay on a regular basis.

You can apply for a personal loan online, saving you time and effort. Most lenders and banks allow you to complete the application from the comfort of your home.

Let’s take a closer look at the loan approval process and how and when your loan amount is paid into your account.

Loan Approval Process

The time it takes for loan funds to be paid into your bank account can vary depending on the lender, the application process, and whether additional documents are required. In some cases, it can take several weeks, although in rare circumstances the funds may be received on the same day.

Once a lender receives your application, they will carry out a credit check to assess your affordability. They will also review the personal and financial information you provided during the application process.

The time taken to approve a loan application can depend on several factors, including:

• The lender’s internal processes
• Whether you already have an account with the lender
• Whether you need to provide additional documents, such as payslips

With LoanTube, the lenders we partner with aim to offer a fast approval process. Once you submit your application, lenders will show you the APRs they are prepared to offer.

Loan Disbursement

In most cases, lenders or banks will deposit the funds directly into your bank account once the loan is approved. Make sure the bank details you provide are correct to avoid any issues.

If your loan is approved, the earliest you could receive the funds is the same day or the next business day. This is more likely if you apply through an online-only lender or a bank where you already hold an account.

In contrast, a personal loan from a credit union may take up to two weeks to be paid out after approval.

Common Reasons for Loan Rejection

When an applicant does not meet a lender’s requirements, the loan application may be declined. This can happen if the applicant is considered too high-risk based on factors such as their financial history or affordability. Each lender has its own lending criteria, so even if one application is unsuccessful, another lender may still approve it.

Some of the most common reasons a personal loan application may be rejected include:

• Low affordability
• A financial association with someone who has a poor credit score
• Making too many credit applications in a short period of time
• Missed or unpaid repayments on a previous loan
• Incorrect or incomplete information in the application
• Insufficient income to support the loan amount requested

If your loan application is declined, it’s a good idea to understand the reason for the decision and address any issues before applying again.

You can take several steps to improve your chances of being approved for a loan in the future.

Check your credit score

If you apply for a personal loan and your application is declined, the lender should tell you which credit reference agency they used to assess your creditworthiness.

You can then contact that agency to request a copy of your credit report. Reviewing your report can help you identify any issues, such as missed payments or signs of fraud, where credit may have been taken out using your details without your knowledge.

It’s also worth checking for errors, such as incorrect payment amounts or mistakes in your personal information. If you spot any inaccuracies, you should contact the relevant organisation and ask for them to be corrected.

Improve your credit score

Your credit score may be one of the reasons your loan application was declined, as lenders often see lower credit scores as higher risk.

Improving your credit score can increase your chances of being approved in the future. Some ways to do this include:

• Registering on the electoral roll
• Keeping up to date with repayments on existing debts
• Making sure your credit information is accurate and current
• Avoid applying again too quickly

Whether your application is accepted or declined, a credit check will leave a record on your credit report.

Making multiple loan applications in a short period can lower your credit score and may suggest financial difficulty to lenders. If your application has been declined, it’s best to avoid applying again straight away.

Take some time before reapplying for a personal loan or any other form of credit.

Pay down existing debts

Reducing your current debts, where possible, can improve your chances of being approved in the future. Making extra payments on credit cards or repaying outstanding loans can help increase your credit score and reduce pressure on your finances.

With fewer existing commitments, lenders may view your application more favourably, as a smaller portion of your income will be tied up in repayments.

Keeping up with your loan repayments can give you peace of mind, help you save on costs, and protect your credit score. Whenever you take out credit, it’s important to borrow responsibly and within your means. Failing to repay a loan can negatively affect your credit score and harm your financial health over time.

Create a Loan Repayment Plan

Managing your borrowing effectively can help you repay your debt more quickly and reduce the interest you pay. Making repayments on time also helps you avoid late fees and improve your credit rating, which can increase your ability to access credit in the future.

Because there are clear benefits to managing loan repayments well, it’s important to have a solid repayment plan in place.

You may find it helpful to schedule key payments, such as your mortgage or energy bills, to go out shortly after you receive your salary. This can make it easier to budget for the rest of the month.

You can also reduce the risk of missing payments by monitoring your account balance and setting up text or app alerts.

Budgeting for Loan Repayments

It’s important to carefully consider how you will repay any loan before taking it out. Understanding the full cost of borrowing can help you make sure the loan is affordable and that you can keep up with the repayments.

Once you know the total cost, you can factor the repayments into your monthly budget to help keep your finances on track until the loan is fully repaid.

Creating a budget is one of the most effective ways to take control of your finances. It helps you understand where your money goes, how much you need for essential expenses, and where you can reduce spending.

Set up a monthly budget that reflects your loan repayments, and commit to sticking to it.

Late Payments and Penalties

Defaulting on a loan can have serious consequences, including the debt being passed to collection agencies or legal action being taken. If the loan is secured against your home or vehicle, you could ultimately risk losing that asset, and your credit score may be negatively affected.

Late payment fees may apply and vary by lender.

The consequences can become more severe if missed payments occur repeatedly. Ongoing missed payments can lead to default, additional interest charges, further late fees, and long-term damage to your credit score.

Loan Refinancing Options

When you refinance a loan, your existing loan is paid off using a new one. The new loan may offer a lower interest rate or a shorter repayment term than the original.

The idea is that by switching to a lower interest rate or reducing the loan term, you can lower the overall cost of borrowing. Future repayments are then made toward the new loan.

If the loan term is shortened, your monthly repayments may increase. However, the loan will be paid off sooner, and you will usually pay less in total interest than if the loan were spread over a longer period.

You may also consider a debt consolidation loan to combine multiple outstanding debts into a single repayment.

Dealing with Financial Difficulties

Breaking the cycle of overspending and mounting debt can be challenging, but addressing the issue directly and creating a realistic repayment plan are essential steps toward getting your finances back on track.

When thinking about how to get out of debt, there are several factors to consider. The first is where to seek expert advice and what options are available to you. The second is how to budget effectively in the future to avoid falling back into debt.

If you feel unable to manage your debts on your own, you may wish to contact a Financial Conduct Authority-authorised debt solution provider. These organisations can assess your individual circumstances and offer appropriate guidance.

Lenders consider several factors when assessing a loan application, and your credit score is one of the most important.

A credit score is a number calculated by credit reference agencies (CRAs) to indicate how well you have managed your past financial commitments and repayments.

There is no single credit score that guarantees approval for a personal loan. Different CRAs use different scoring methods, which means the score you receive can vary between agencies.

Let’s take a closer look at how credit scores relate to personal loans.

Impact of Personal Loans on Credit Scores

By consistently making timely payments on your personal loans, you can improve your credit score over time. When you formally apply for a personal loan, a hard credit check is carried out, which involves a detailed review of your credit history. While some checks may remain on your credit record for longer, a hard credit check typically stays on your file for around one year.

Submitting multiple loan or credit applications within a short period can negatively affect your credit score. For this reason, it is sensible to apply for a loan only when you are confident you meet the lender’s requirements.

Building and Improving Credit History

Making timely repayments shows that you are a responsible borrower and can help improve your credit score. However, increasing your score also requires effectively managing all your other credit commitments, not just one loan. Over time, establishing a consistent record of on-time repayments can help strengthen your credit history.

Your credit score may also improve if you consolidate unpaid debts into a personal loan, as this can make your repayments easier to manage and reduce the risk of missed payments.

Managing Multiple Loans and Credit Accounts

Your credit mix is often taken into account by credit reference agencies when calculating your credit score. This refers to the range of different credit products you have, such as personal loans, credit cards, and mortgages. Managing various types of credit responsibly can show lenders that you are able to make payments on time, even when handling multiple credit commitments.

With interest rates rising, taking the time to research before applying for a personal loan can be worthwhile. Personal loan rates vary between lenders but are typically lowest for borrowing amounts between £7,500 and £20,000. Where the interest rate is fixed, your monthly repayments will remain the same throughout the chosen loan term.

Let’s take a closer look at how to compare personal loans.

Comparing Loan Providers

Comparing personal loans before borrowing can help you find an option with an interest rate that suits your individual circumstances. There are many lenders and banks offering personal loans, and without researching and comparing the quotes you receive, it can be difficult to know which rate is best for you.

You should also make sure you deal only with lenders authorised by the Financial Conduct Authority (FCA).

Comparing Interest Rates

To compare quotes from multiple lenders, you usually need to complete an application on each lender’s website. After you submit an application, lenders will assess your details and carry out a credit check to review your affordability, before offering an interest rate based on your current and previous borrowing behaviour.

Once you receive quotes from several lenders, you can compare the offers for your loan amount and choose the lender offering the most competitive interest rate.

Loan Terms and Conditions

It’s important to read the fine print of a personal loan agreement so you fully understand the terms and conditions you are agreeing to. This will help you identify any fees, obligations, or conditions set by the lender. If you have concerns or do not agree with any part of the agreement, contact the lender to discuss it before signing.

Avoid signing the agreement without reviewing the fine print, as this could result in unexpected charges later. Overlooking key terms may mean you are required to pay fees or costs you were not anticipating.

Hidden Fees and Charges

You pay interest on the amount you borrow. While it may not always be thought of as a fee, interest is how lenders typically earn money and cover their costs. In addition to interest, some personal loans may include other fees, which are outlined below:

Late Payment Fee

Lenders may charge one-off fees for late repayments. Missing loan payments can also negatively affect your credit score, making it harder to access credit in the future. Check your loan agreement or ask your lender about any charges that apply if you miss a repayment.

Set-up Fee

A set-up fee is a one-off charge that covers the cost of arranging and managing a loan. It may also be referred to as a product fee, admin fee, loan fee, or lender fee. Some lenders allow this fee to be added to your loan balance if you prefer not to pay it upfront.

Early Loan Repayment Fee

Many lenders state that making extra repayments or repaying a loan early will not incur fees. However, some may charge up to two months’ worth of interest on amounts repaid early, and this information is often set out in the fine print.

For this reason, it’s important to read the terms carefully when comparing loan quotes and choose a loan that best suits your financial needs.

Customer Reviews

Reading customer reviews and ratings is another important step when considering a personal loan. Feedback from existing or past customers can help you understand the type of lender you may be dealing with. If you come across negative reviews, try to understand the reasons behind them and carry out your own research to make a more informed decision.

In the UK, mortgage lending and consumer lending are regulated activities. In certain circumstances, a lender must be authorised by the Financial Conduct Authority to carry out these activities.

Let’s take a closer look at how personal loan lending and borrowing are regulated in the UK:

Consumer Rights and Protection

Borrowers have rights under the Consumer Credit Act, which is designed to protect consumers from exploitation by lenders or other financial institutions. If you face any issues with your loan or its repayments, there are different ways to tackle them.

Financial Conduct Authority (FCA) Regulations

Any company that offers credit or financing to consumers, not just specialist lenders, must be authorised by the Financial Conduct Authority. If a lending company is not authorised, you should report it to the FCA and avoid dealing with it, as doing so could expose you to financial fraud.