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We get it. Taking out a loan can be confusing, especially if you don’t understand the process. We’re here to help you break down what you need to know to find the right loan. Retake control of your finances. We’ve got your back.

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Representative 49.9% APR. Representative Example: If you borrow £2000 over 24 months at a Representative rate of 49.9% APR and an annual interest rate of 41.2% (fixed), you would pay 24 monthly instalments of £123.64. The total charge for credit will be £967.43 and the total amount payable will be £2967.43.
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Table of contents

Written by Mark Grimley
Read time: ~5 mins
Published: 4th April 2016 Updated: 29th July 2022

What is a loan?

A loan is when you borrow money from a finance company, like a bank or building society. You might need to borrow money to fund all sorts of things, like a car, home improvements or when you get married. When you get a loan, you'll need to pay back the amount you've borrowed in monthly instalments until you’ve paid back everything you owe.

You'll also have to pay something called ‘interest’. This is an extra amount that’ll be a percentage of what you owe. How much interest you’ll pay will be agreed before you take the loan out and is represented as APR and will be different depending on your circumstances.

APR represents the amount of interest you’ll be charged on top of the amount you borrowed. It’s presented as a percentage per year and factors in the costs of any standard fees you may have to pay. An APR is there to help you figure out how expensive a loan will be and helps you to easily compare loans. In simple terms, the higher the APR, the more expensive the loan is.

Personal loans comparison

How do loans work?

Applying for a loan will usually follow the same process:

  • You give the loan company some personal details, such as how much you earn from any jobs or income and explain how much you would like to borrow.
  • You'll then also choose how long you’ll take to repay the money you’ve borrowed. You can choose a short-term loan that's usually paid off within 24 months or a longer-term loan that could last up to twenty years. The length of your repayment plan will affect how much you’ll need to pay back monthly.
  • The loan company will review your details and check your credit history, looking into whether you’ve kept up your repayments on other forms of credit in the past, like your household bills.
  • After reviewing your details, the loan application will either be accepted, rejected, or deferred. If accepted, the loan provider will then offer you an annual percentage rate, also known as APR. If deferred, it means that the loan provider needs more time to complete extra checks on your credit file.
  • Once your loan is accepted, you’ll make your first repayment, either at the end of the month or thirty days after taking the loan out.
  • You’ll pay off your loan every month. Interest will also be added to your outstanding balance, increasing the total amount you have to pay. Interest is charged because that’s how loan companies make a profit from lending you money.

What can you use a loan for?

Common reasons for taking out a loan include:

  • Buying a car
  • Making home improvements
  • Paying for an emergency repair
  • Consolidating debts
  • Paying for a holiday
  • Covering wedding costs

There's no right or wrong thing to spend a loan on; it's entirely your call as long as it’s within the terms of the lender. Before getting a loan, make sure you can afford the monthly repayments and don’t forget to add the repayments into your budget.

There are loads of free apps available that can help you to figure out your monthly budget and keep on track of your spending so you don’t fall behind on the bills.

What are the different types of loans?

There are plenty of different loans on the market. This makes it more likely to find one to suit your situation, but we get the differences can sometimes be confusing. We’re going to walk you through the different types of loans below.

Unsecured personal loan

This is the most common type of loan and can be used for anything you want.

Unsecured means any property you own isn’t tied into the loan as a guarantee. Interest rates on an unsecured loan tend to be higher because they aren’t secured on your home. If you don’t own a house, then an unsecured loan is the type of loan you’ll want to consider.

Secured loans

A secured loan is where your home is used to guarantee the loan repayment. This means if you can't keep up with your monthly loan repayments, your home could be repossessed and used to pay off the loan.

A secured loan is less risky for the lender, meaning they tend to offer the best loan rates and allow you to borrow more money. They’re also usually repaid over a longer period of time, making each monthly instalment cheaper as a result.

Specific purpose loans

You can get loans that can only be used to buy certain things. For example, you can get car loans that can only be used to buy a car or home improvement loans that can only be used for projects to upgrade your house.

The benefit of these types of loans is they offer lower loan interest rates compared to general personal loans.

Bad credit loans

These are personal loans with higher interest rates, designed for you if you have a poor credit history. There are lots of different reasons people have a poor credit history - so don’t worry. Providing you keep up your repayments, bad credit loans can help you build your credit history, making it easier to be accepted for credit in the future.

Guarantor loans

This is an unsecured loan where a pal or family member guarantees the loan for you. If you can't repay the loan, this person will have to pay it back on your behalf.

When applying for a guarantor loan, the person who guarantees the loan for you will also have their affordability and credit report checked.

These types of loans tend to have a higher APR than other loans but can be a good option if you're getting rejected elsewhere.

Payday loans

Payday loans are a type of short-term loan designed to tie you over until you next get paid. These types of loans have a bad reputation because of a few rogue lenders who are no longer on the market. It’s true that these loans charge high interest rates on small loans, but they are designed to be used in emergencies.

Bridging loans

A bridging loan is a type of loan where you pay what you've borrowed off in one lump sum.

The most common scenario where bridging loans are used is when you're waiting to sell a house, where the bridging loan is used to pay for your next property.

How much do loans cost?

When you take out a loan, you'll be charged interest on top of the original amount you’ve borrowed.

The APR of the loan dictates the total amount you’ll repay.

So, for example, if you've taken out a loan for £4,000 and paid it back over twelve months with a 40% APR, you'll need to pay back approximately £4,777. This is an illustrative example and the exact payment term should be agreed with a lender.

The loan length also plays a part in shaping the cost of your loan. The longer you take to repay what you’ve borrowed, the more time there is for your balance to accumulate interest, resulting in your loan being more expensive.

Because interest compounds, which is where interest is applied to interest, a loan of £4,000 with an APR of 40% spread over ten years will cost more than the same loan being spread over five years.

Although the total cost to you is greater, spreading a loan over more months will reduce the amount you repay each month, making it more affordable in the short term.

The APR of loans can vary between the best loan companies, depending on the types of loans. A bad credit loan or guarantor loan will usually have a higher APR than other personal loans. Your credit history and income will determine what APR you're offered when you apply.

Calculate the costs of your loan

Choose Wisely has a Loan Calculator to help you better understand the cost of loans and find the right loan for you.

If you’re not in a rush to borrow money, to improve your chances of getting a good interest rate, meaning you’ll save money, you could try improving your credit score first.

Other costs may also be added to your loan. What you're charged for will differ between money lenders, but you should expect fees and charges to include:

  • Paying off the loan early - called an early exit fee
  • Missing a repayment - called a missed payment charge

These extra charges can increase the cost of your loan.

How can I improve my credit score?

Building your credit report can make it easier to get the loans you want with favourable terms. Here are some things you can do to boost your credit score:

  1. Check that the details on your credit file are correct

  2. Make sure you are on the electoral roll

  3. Check who will accept your application before you apply direct

  4. Ensure you enter complete and accurate information in your application

  5. Refrain from making multiple applications in a short space of time

How do i know if I'm eligible for a loan?

The eligibility criteria will differ for each type of loan, based on each lender's preferences.

For example, if you're finding it tough to be accepted for an unsecured loan because of a poor credit score, you may be accepted by bad credit loan lenders. Or, if a traditional bank declines your loan application, you may be accepted by an online-only lender.

Your eligibility will be determined by your credit score, creditworthiness and disposable income.

Despite the different criteria between lenders, every one of them will require you to be over 18, a UK resident, and pass a credit check.

When looking to see if you're eligible for a loan, don't just take a blind stab at it; use our eligibility checker before you officially apply.

Each time you apply for a loan, your credit report will be checked, also known as a hard search. A hard search leaves a mark on your credit report. Too many searches of your credit report in a short period of time can harm your credit score because it makes you look desperate for credit.

So, before applying for a loan, use our Credit Search to see how likely you are to be accepted for a loan without harming your credit score. Getting an insight into your credit report can also allow you to apply for loans with more confidence.

What do i need to apply for a loan?

You will need to dig out some documentation for your application. You'll need:

  • Proof of identity. This can be a passport or UK driving licence, as long as they're valid and in-date. A bank statement under three months old will also help.
  • Proof of residence. Something like a utility bill, mortgage statement, or water bill that includes your name and address will be able to prove your residence.
  • Proof of right to live and work in the UK. If you have a UK passport, this will be enough, but documentation like an EU settlement statement or work visa will work if you don't.
  • Proof of income. This can be a payslip, bank statements, or any other evidence of income.
  • Employer details.

You will also need a UK current account to get a loan. This is so you can receive the loan and make your repayments. Before applying for a loan, make sure you’re able to set up standing orders or direct debits via your bank account.

Pros and cons of personal loans

  • Give access to funds to finance large purchases
  • They can cover a drop in short-term cash flow
  • Can improve your credit report
  • They're quick to get approved
  • They're flexible
  • They can have a high APR
  • Your credit report can be harmed
  • Loans have unavoidable fees
  • Fees and penalties for missed payments
  • Other forms of borrowing may be more suitable

Are there any alternatives to loans?

Sometimes, getting a loan isn't always the answer. Here’s a few alternatives:

Credit cards

If you need to borrow a small amount of money over a short period of time, a credit card may be a good option for you.

With credit cards, you can borrow smaller amounts, making them easier to manage. Some credit cards may charge you high rates of interest. However, most will have an interest free period, meaning if you pay what you owe back in this timeframe, you won't be charged interest.

Borrow from friends and family

If you're in a difficult financial situation, you could consider borrowing money from your family or friends. We understand it can be awkward asking to borrow cash from people you know, but you can avoid paying large amounts of interest this way.

When you borrow money from loved ones, you’re always taking a risk that your relationship could be ruined if you’re unable to pay them back, so write down on a piece of paper how much you’re borrowing and when you promise to pay it back by so you both feel reassured and it’s clear what you’re both agreeing to.

Salary advance

The last week before payday can be tough, running out of money to pay for things like food and fuel can be incredibly stressful. If you need a small amount of cash to tie you over, you can ask your employer for a cash advance.

When times are tough, this can help you but remember it will lead to a smaller paycheck the following month because you've received a portion of pay early.

Loan FAQs

Can I get a loan with bad credit?

If you have a poor credit history or there are things on your report preventing you from getting a standard loan, it's still possible to borrow money. Bad credit loans are likely to be more expensive because they’ll charge higher interest rates.

It has been known for traditional high street lenders to be dismissive towards people with poor or no credit history, so it may be easier to apply to specialist loan companies with loans that are designed for people with bad credit.

How much can I borrow?

Each lender will have a minimum and maximum amount you can borrow with them. This amount will not be the same across all providers and will be dependent on the type of loan they're offering.

The amount you can borrow as an individual will be affected by your personal financial situation. When applying, your disposable income will be checked, which is the amount of money you have leftover after paying for bills. This will determine how much you can borrow.

On average, the most you can borrow with an unsecured loan is around £10,000.

With a secured loan, where your home is used as collateral, you'll be able to borrow more, typically up to £500,000. This will depend on how much your home is worth.

Can I pay off my loan early?

You can, but you may have to pay an early repayment fee and can be pretty costly. Usually, an early exit fee will cost the same as two instalments.

What if I can't afford to pay my loan back?

If you're in a position where you won't be able to make a loan repayment, contact your loan provider as soon as possible. By doing this, you may be able to negotiate smaller monthly repayments or a repayment holiday.

Missing repayments will mean you’re charged fees and your debts could quickly build. If you’re unable to pay back your loan, your debt may be sold to a third party who could choose to take you to court. This can seriously affect your credit rating, making it hard to get accepted for any credit product in the future including mortgages, credit cards, mobile phone contracts, car finance and renting accommodation.

If you've taken out a secured loan, your home may be repossessed to pay for the loan.

Will a loan affect my credit score?

Yes. It will.

If you manage your loan well by repaying what you owe on time and clearing the debt, this can improve your credit report, demonstrating you’re a reliable borrower for future lenders.

But, if you’re late paying or miss repayments, it will harm your credit score, making it tougher to get credit in the future.

Written by
Mark Grimley
Head of Partnerships & Take Control Author at Choose Wisely

Mark joined Choose Wisely in 2015. He continues to work in close contact with the providers, brokers and journalists operating in the world of consumer credit.

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Important Information.

All of the information in this guide is correct at the time of writing.

If you complete a loan search application on Choose Wisely, the rates shown may vary based on your personal circumstances, are subject to status and are available to those aged 18 and over. Rates available range from a minimum of 3.9%APR to a maximum of 1575%APR Representative and loan repayment periods range from 3 to 60 months.

[*][†] Once accepted, your loan can be transferred to you in as little as 15 minutes. The time that it takes for the loan to show in your bank account will depend on your lender and your bank.

If you need financial advice you can visit stepchange, speak to citizens advice, call the national debtline or speak to moneyhelper.org.uk.

If you've been declined, please refer to your credit report to gain an understanding of why before making further applications.
Your score can be accessed for free via any of the main credit reference agencies such as Credit Karma, Clearscore or Experian.

Warning: Late repayment can cause you serious money problems. For help, go to moneyhelper.org.uk