Why might a person want a loan?

Usually people have a big outgoing payment in their future – for example a car, or home improvements, or they want to consolidate their debts. Other people may want a loan to start up their business.

Why might a person want a loan?

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What are the types of loans that are available to individuals

There are two categories of loan – secured and unsecured. A secured loan means the lender asks for security against your debt, which is generally your house or car. An unsecured loan is debt that is not secured against any of your assets. There are pros and cons to both.

With a secured loan, it’s possible to borrow a high amount, have a low rate of interest and repay the loan slowly (perhaps 5/10 years). However, they are more risky than unsecured loans because you could lose whatever you put up a security against the debt if you cannot repay that loan.

With unsecured loans, the debt is not secured against any of your assets. This means that you borrow a fixed amount for a fixed term with a fixed amount of interest to be paid. You set up monthly repayments until the debt is cleared. For this type of loan, your credit score is key. If your score is low, lenders may refuse to lend on the basis you’re not responsible with money.

An unsecured personal loan is a popular application choice, but it really is an individual’s choice, and of course, the decision is dependent on your credit score.

If your credit score is bad, there are “bad credit loans” and their interest rates are much higher. However, sometimes it’s necessary to borrow to get you out of trouble and a specialised bad credit loan is what you need. There are three sorts of BCLs:

1) unsecured

2) a guarantor loan (someone commits to paying for you if you default)

3) a peer-to-peer loan (your loan comes from an individual rather than a bank)

How are loans fifferent from credit cards?

With loans, you usually have to explain why you’re applying for them. A tangible reason like refurbishment work on your house, or buying a new car is likely to be approved, while saying the loan will supplement your disposable income is not likely to be approved. Put yourself in the bank’s shoes – they need to be confident that you will have the means to repay the loan.

Loans are also different from credit cards as there is more flexibility on how long you have to repay the debt. So hypothetically you can choose to repay £10,000 over 2 years, or over 10 years. If you repay in 2 years, your monthly repayments are high, but you pay less interest for the loan. If you repay in 10 years, your monthly payments are much lower, but you end up paying more for the loan in interest.

How do the Banks calculate interest?

Loans are advertised with a percentage APR attached to them. That annual percentage rate is the interest your pay on the money you have borrowed. The APR also incorporates the fees incurred in taking out a loan / the charges of structuring the deal so that you go into the loan with your eyes open as to what you need to repay.

Do remember though that advertising is sneaky. When you see the “representative APR rate” – all that means is the bank is obliged to offer that rate to at least 51% of applicants, it does not mean you are guaranteed to receive that rate. It’s all based on your credit score.

Final fact from Mr Financial, with any loan, it is so important that you check all the fees and charges of the loan and check about overpaying and deferring payments, so nothing comes back to bite you.

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