There are many different types of loans but the most simple version is a personal loan.
This is where a bank, building society or other lender gives you up to £25,000 which must be paid back over a set period of time with a fixed interest rate.
Personal loans are usually available to repay for between three and ten years, with payments made once a month.
When choosing one, don’t just consider the rate itself as this won’t tell you the cost in pounds and pence.
Ensure you weigh up exactly how much the loan will cost by asking for the total cost of credit, which is the cost of the interest.
The amount you borrow, the rate charged and the length of time it takes to repay the loan all affect the total cost of credit.
To highlight the real cost of a typical rate, say you borrow £5,000 at 10% annual interest over five years, it will cost roughly £1,370 in interest, meaning you pay back £6,370, at just over £106 a month.
The longer the loan length, the less the rate typically is but that does not necessarily make the personal loan cheap.
Say you’re borrowing £5,000 at 10% annual interest over three years, you’ll pay approximately £800 interest. Borrow the same amount at 5% over ten years and you’ll pay around £1,360 in interest – £560 more.
The amount you borrow also affects the loan rate. Using a snapshot example of personal loan rates at time of writing, someone borrowing between £1,000 and £2,000 could pay more than double the rate someone borrowing between £7,000 and £15,000 pays.
Once you’ve got a personal loan, don’t assume you’re stuck on it. These days, when you find a cheaper rate elsewhere, switching loans may save you cash. This means paying off your existing personal loan with the funds from the new loan.
You’ll get a small penalty of one of two months’ interest but if you pay off a loan early. On a £5,000 loan at 5% interest, you could be looking at a £100 fee. So do the maths, factoring in the charge, as to whether it’s worth switching.
Anyone with a loan taken out before June 2005 may not be so lucky as lenders can charge huge amounts to pay off your debt early on such loans, which could make switching pointless.
To get the lowest rate you often need to have a decent credit score. Therefore, those who have missed debt repayments or have excessive amounts of debt may not qualify for the best rates.
One thing to bare in mind when choosing a loan is that advertised rates are only “typical”, which means lenders only need to offer them to two thirds of those accepted.
By definition, one third will pay more, so be prepared, especially if you don’t have the best credit history.