How do loans work?

With all the financial jargon and variety of options on offer, it can sometimes be difficult to wrap your head around how loans actually work.

However, with all the right information, it’s a lot more simple than you may think. To help out, this article will answer some frequently asked questions about loans and outline how they work. 

How does a loan work?

Fundamentally, a loan is a commitment between you (the borrower) and a lender. Within this commitment, you will borrow money from the lender and pay back the total, with additional interest. The terms of this loan are defined within the application process and can result in varying degrees of interest and repayment time. When approved, the borrower will pay the lender the principal amount plus interest on the agreed terms every month, until the payment has been made in full.

There are two main types of loans out there: 

• secured loans
• unsecured loans

A secured loan is ‘secured’ against one of your direct assets – such as a car or house – so you can guarantee repayment if you aren’t able to pay the loan back on the terms agreed. Generally, borrowers tend to borrow more money when applying for a secured loan. Due to the collateral, secured loans typically have lower interest rates too.

In contrast, an unsecured loan allows you to take money out without putting up anything you own and is what most people think of as a traditional loan. The ‘unsecured’ part means that if things go wrong and you cannot repay your loan the lender will not be able to take control of your assets, with the opposite being true for secured loans.

For example, here at Koyo, we supply unsecured personal loans and use Open Banking to assess the affordability of the borrower. 27.9% APR Representative. While both types of loans are fundamentally different, they work in the same way in terms of borrowing and repayment.

Money from your loan can be used in a variety of ways. Many people use loans for home improvements, debt consolidation or even a bigger purchase like financing a car. Additionally, many borrowers also use their loans for weddings and holidays. There are plenty of ways to use loan money efficiently and effectively.

How do I apply for a loan?

Before a loan can be taken out, the application process must first be completed. This process involves supplying personal and financial information from the applicant, such as:

• Title and name
• Email address and phone number
• Date of birth
• Nationality
• Marital and residential status 
• Current address
• Employment status, employer, job title and industry
• Gross annual income and monthly rent or mortgage payment
• The reason for the loan application

This information allows the lender to accurately determine if you can comfortably afford to pay back your loan within a certain timeframe. After this information has been submitted, the lender will do a credit check before making a final decision on the loan application.

Some lenders, such as Koyo, use Open Banking to fairly and safely determine whether a customer is suitable for a loan. The application process is often quicker than you may think too, with Koyo normally approving loans within one working day. 

How does credit history affect a loan application?

Credit history can play a big role in many loan applications and will have an impact on the rate of interest you pay back. Those with a strong credit history will be trusted more by the lender, allowing you to apply for higher loan amounts and lower interest rates. If your credit score isn’t in a great place, it’s a good idea to build it back up before you apply for a loan. For those still unsure about their credit score, we suggest double-checking with an independent credit checker before applying.

However, some online personal loan lenders, such as Koyo, don’t only use credit scores to determine whether a borrower is eligible for a loan. Open Banking is now used fairly and safely to evaluate loan applications, with Koyo using data provided by a third-party called Truelayer (regulated by the FCA) to assess and validate financial information. 

If you’re looking for a flexible personal loan of £1,500-12,000, you can use our loan calculator or submit an application at www.koyoloans.com. 27.9% APR Representative.