The Four Main Types of Personal Loans

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Most people assume that a personal loan is a one-dimensional product that does not offer many options. This is not the case. Borrowers have several personal loan options at their disposal, and their choice depends on the amount and context of a loan. Before rushing into the first personal loan deal you find, understand the different types and their implications.

Unsecured loans

An unsecured loan does not require you to offer any collateral to the lender to guarantee repayment. A prime example of this is short-term loans, which last between one and six months. Independent lenders offer these loan products as an alternative to traditional banks, and borrowers can even apply for them online.

A payday loan is one that you repay in a single lump sum after your next income date. However, many lenders offer terms of up to three months if the amount borrowed exceeds a certain amount. A personal loan usually has a repayment period of between six months and five years. The amount borrowed varies from £1,000 to £25,000.

When applying for a short-term unsecured loan online, a payment calculator lets you enter your loan amount and preferred repayment method. This gives you a monthly instalment amount to compare with your budget. Some lenders offer a payment holiday at the commencement of the loan, where you do not make any repayments for up to the first three months.

Interest rates charged on unsecured loans tend to be higher because there is no available collateral for the lender to seize if you miss payments. Expect the interest rate to increase as your preferred payment period decreases. In other words, the interest rate on a 12-month loan will be higher than that on a 36-month loan.

Lenders might advertise a certain interest rate, but terms and conditions apply, with the most important one being a good credit score. With a less than stellar credit history, you could still obtain a loan, but lenders will charge more interest because you present them with a greater risk of default.

Secured loans

A car finance loan is regarded as a personal loan, even though you are using it to make a substantial asset purchase. You might choose to make this loan type unsecured, but there are some advantages to opting for a secured loan. For example, you can expect a lower interest rate and higher loan threshold.

A secured loan is a financial transaction that requires you to offer collateral against the borrowed amount. When financing a car purchase, you offer the vehicle as surety to the lender. This authorizes your bank to seize the car if you do not make repayments.

The lender sells a client’s repossessed vehicle and uses the funds to settle an outstanding loan balance. Therefore, a secured loan presents a lower risk to lenders who know they will recoup funds if you default. But there is an increased risk for borrowers who could lose every pound they repay and the asset if they cannot meet their monthly repayment obligations.

Guarantor loans

Your credit history weighs heavily into a lender offering a loan at competitive interest rates. If yours is somewhat spotty, lending institutions would regard you as a risky prospect as past behaviour predicts future actions. Therefore, your failure to repay previous debts makes lenders wary of entering a loan transaction. They might turn you down, offer a lesser loan amount, or charge you more interest.

Avoid this by getting a friend or relative with a better credit history to sign as a guarantor. This makes them liable for repayments if you default. These loans are unsecured. Bear in mind that bringing finances into personal relationships can be dangerous, especially if payments stop. Then the guarantor has your lender on their case to repay funds that you borrowed. Their credit score will consequently suffer.

Debt consolidation loans

When facing a debt crisis, you should consider a debt consolidation loan. Think about how many companies you owe money to. Every time you miss a payment, the balance grows, and interest is added.

In some cases, such as short-term loans and credit cards, interest rates are high, and you could end up paying more than double the loan amount. Your credit score is continuously declining, and the odds of securing finance in the future are getting worse.

To avoid this debt trap, consider a debt consolidation loan. Use the money to pay off outstanding loans and accounts. Afterwards, you have a single creditor to pay. Negotiate terms with the lender that provide sufficient time to repay a debt consolidation loan in affordable instalments.

The interest rates on such loans might be somewhat high, but they remain lower than those charged by credit card companies and short-term lenders. Once you have secured a debt consolidation loan, use it as an opportunity to start on a new page and avoid borrowing any additional money.

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