Have you ever asked yourself “what is an unsecured loan”? I mean, as opposed to a ‘secured’ loan?
It sounds dodgy but, weirdly, an unsecured loan actually less dodgy than a ‘secured’ loan. With an unsecured loan you’re not likely to lose your house or your car whereas with a secured loan you might.
If you’re thinking of getting a loan then we suggest you read our simple guide to unsecured loans before you do anything else. Secured loans may have better rates, but if you go for the right unsecured loan, you’re likely to be better off long-term.
We’ll take you through the ins and outs as well as showing you how to find the very best deal.
- What is an unsecured loan?
- How do I choose the best unsecured loan?
- Try your own bank first for a loan!
- Borrowing from Credit Unions
- Borrowing from Social lending Sites
As peculiar as it may sound, unsecured (or personal) loans actually offer you better security than secured loans.
They are ‘unsecured’ because the banks generally have nothing to take from you if you default – the lender relies on your promise to pay the loan amount back.
This is in contrast to secured loans, which are ‘secured’ against assets such as your house, which the bank can repossess and sell if you fail to keep up with your payments.
So, what is an unsecured loan, as opposed to a secured loan? Secured loans offer the banks the security, not you!
secured loans have better rates
While a loan secured against your possessions will almost always get you a better lending rate, and be much easier to obtain, in almost every case it isn’t worth the risk. Imagine watching your home being repossessed for failing to pay back a loan of £5,000! Take a look at our article on secured loans here for more information.
With an unsecured loan, the lender is taking a big risk which is why interest rates tend to be higher than with secured loans.
Most lenders will offer loans of between £5,000 and £25,000, although you may find that some will cap borrowing at £15,000.
Generally, there is a set amount paid back monthly over an agreed period of time, and penalties often apply (e.g. two months interest) if you want to pay the loan back earlier. The interest rate will either be fixed (more often than not), or variable.
There is an overwhelming number of unsecured loan options out there, and it can be daunting. When choosing a personal loan for yourself, you will be faced with two major questions:
1) How much money do I want to borrow?
Think about this carefully. You want enough to cover the costs you expect with a little in reserve for unforseen circumstances. Believe it or not, it can work out cheaper for you to borrow more. When you reach a certain amount of money lenders tend to offer better rates. For example:
£4,800 @ 12.9%APR = £5,814 (3 years)
£5,000 @ 8.5%APR = £5,682 (3 years)
It often pays to be flexible with how much you want to borrow, and you might just find that you can get more for less! That said, you don’t want to be borrowing loads more than you need. It’s simply not worth it, because you’ll end up paying for it in the end anyway.
2) Over what period of time do I want to pay my loan back
The longer the repayment period, the more interest you pay overall, even though your monthly payments will be smaller.
Don’t be swayed by a tiny looking interest rate over a lengthy period of time. The longer you take to pay a loan off, the more you will pay altogether because you pay interest for longer.
Interest is like rent. You pay to rent money when you borrow it. So, just like renting a flat, the longer you have it for, the more you will pay in the long-run.
As a rule of thumb, always go for the least amount of time to pay back your loan that you can realistically afford. Always work out the TAR (the total amount repaid) – that’s how much the debt will cost to pay off altogether when you add up the amount you have borrowed plus the amount you will have paid in interest – and judge on that basis, rather than jumping for the smaller interest rate.
Before 2011, when you were shown a ‘typical’ interest rate quoted either on the lender’s advert or on a comparison site, the bank had to have offered this typical APR (annual percentage rate), or a better rate, to at least 66% of it’s potential customers.
Since Febuary 2011, that figure now only has to be 51%.
Whilst this sounds like a bad thing (because fewer people are actually getting the advertised rate), if you have a good credit rating, it may be beneficial.
Believe it or not, going to your own bank first is a wise starting point.
Your bank knows you best, and if you have a long-history of good credit with them they may be willing to offer you a bumper deal, on better terms, than you’ll find elsewhere.
This doesn’t mean that you shouldn’t consult the comparison websites.
Depending on your individual needs, and your credit history, you may still find the best deal there.
What to watch out for
Even if you do find a loan on a comparison site that you want to apply for, be wary.
Whenever you apply for a loan and are rejected, it will reflect badly on your credit record.
First things first, check your credit rating for free here.
That way you’ll know how good your chances are of getting the most competitive interest rates before you start.
If you are concerned, you can phone up the lender that you’re interested in obtaining the loan from, and ask for a ‘soft’ credit check. This won’t have any impact on your credit record, and the lender should be able to give you a good idea of your chances without going through with the full credit check.
Also, on our loans comparison service, you can check first to see if you would be eligible for the loan before you jump in.
While credit unions aren’t that big in Britain yet, they’re steadily growing in size and number. They function somewhere in the realm between a bank and a cooperative, and offer high savings and low lending rates for their members.
Traditionally considered for those who can’t get a loan with mainstream lenders, credit unions have been shrugging this tag off in recent years and now offer some deals to rival the big banks.
Before you can take a loan out with a credit union, you need to be an established member of the union and have already put some savings into their coffers. This is because credit unions are completely controlled by their members; they encourage members to save regularly, and use these savings to provide loans to members at low rates of interest.
By law, credit unions cannot charge more than 2% a month on the reducing balance of the loan (an APR of 26.8%), with most charging 1% (an APR of 12.7%). Some charge more, some less, with most offering unsecured loans for up to 5 years.
You can often find better rates with some of the bigger credit unions than high street banks, and especially since the financial crisis, it’s nice to know that any profits are funneled back into the union, rather than into the pockets of the already minted City bankers.
There are no hidden charges, no penalties for repaying the loan early, and life insurance is built in at no extra cost – so if you die before repaying the loan, it’s covered by insurance.
To find one that you can join, look at findyourcreditunion.
If you have a top credit rating, then social lending sites are a really good idea.
The reason why we say it helps to have a top credit rating is because these sites generally have a stricter lending criteria than banks, and this is what brings down the risk for lenders, and the interest rate for borrowers.
Social lending, or peer-to-peer lending, offers consistently better interest rates than banks. By cutting out the middle-man (well, there’s still an online intermediatry of sorts), you can essentially borrow more for less.
With Zopa you can borrow anything from £1,000 to £25,000 and on Ratesetter.com you can borrow anything from £500 upwards, with each loan being individually assessed.
Getting behind on your payments?
If you get behind on your payments, or feel like you won’t have enough cash to cover the upcoming direct debit, whatever you do, don’t ignore those letters! Get on the phone to your lender and inform them of your situation.
Often you will find that your lender can help, and may offer you anything from a 2 month amnesty to a cheaper rate. Even if they don’t offer you any help (and this is very rare), you have let them know what to expect, and they may waive a late fee or two.
Check out our Seven quick ways to pay off debt article for more help, and remember that you can get free help and advice from:
- Citizens Advice Bureaux (CAB) which provide free, confidential and independent advice from thousands of locations in the UK
- StepChange is a debt charity offering an online debt remedy service and free debt advice in person or on the phone.
- Christians Against Poverty is a national, free debt advice service that runs through local churches.
- Nationaldebtline is a website offering a guide to dealing with debt – and has some useful sample letters for writing to creditors.