The pros and cons of personal loans

An unsecured personal loan is probably the simplest way to borrow money there is. It’s straightforward, hassle-free and should come with no strings attached.

But is it the best way for you to borrow money? That’s an excellent question, and in this article, we’ll explain what a personal loan is, before running through the pros and cons – with the aim of helping you to make an informed choice when you’re considering borrowing money.

Before we get started, if you’re looking for a flexible personal loan of £1,500-12,000, you can take a look at our loan calculator or make an application at www.koyoloans.com (representative APR 27%).

If you’d like to know more though, read on!

What is a personal loan?

A personal loan works like this:

• You borrow an agreed sum of money, which you receive as a lump sum into your bank account

• You repay that amount, plus a fixed rate of interest, for an agreed term

• Once you’ve made your final payment, that’s it!

Personal loans are very simple (more so than most other credit products), and you can get a personal loan for lots of different reasons, from renovating your home to buying a new car. In fact, they can also be used to pay off other, more expensive forms of debt.

Applications are usually straightforward and can be done online – in some cases, you can have money in your account in as little as 48 hours. We’ve put together a separate guide to the documents you need to apply for a personal loan, but it’s a relatively easy process.

Secured vs. unsecured loans

A personal loan can be either secured or unsecured.

A secured loan, such as a home equity loan, takes its name from the fact that an asset you own – usually your home – is taken as “security”, meaning that the lender has a claim on it if you fail to repay your loan in full.

Unsecured loans are much more common, especially for loan amounts below £20,000, and are much less risky for the borrower, since you’re not required to put your home as security.

Koyo loans are unsecured, and in this article, that’s what we’ll be focusing on.

What are the advantages of a personal loan?

Spread the cost of purchases over time

The main benefit of a personal loan – and credit in general – is that it allows you to spread the cost of a significant purchase over a longer period.

It’s always cheaper to buy in cash (we’ll cover that later), but if that’s not possible, a personal loan allows you to bring forward an important purchase – for example, a car to get you to work, or new windows to keep your house warm over winter.

It’s important to note that a loan isn’t a way to live beyond your means – you should always consider whether you really need to make a purchase now and make sure that you’re comfortably able to make all repayments, even if your circumstances were to change.

Flexible and can be used for many different purposes

One of the major advantages of a personal loan is that it’s flexible. You can use a personal loan for just about anything, and if, for example, you’re making home improvements, you could shop around and choose to use part of a loan to hire builders and the other part to buy some new appliances. That compares favourably to store credit, for example, where you’re tied to a particular provider.

Another advantage is that many providers allow you to repay your balance early – for example, Koyo allows you to pay off your loan at any time, with no hidden fees or prepayment penalties.

Lastly, an advantage compared to credit cards is that with a personal loan, you receive a lump sum – effectively cash. Some providers won’t accept credit cards, so if you’re buying with a loan, you might find yourself at an advantage.

Helps to build your credit score

Taking out credit and repaying it will usually have a positive impact on your credit score. That applies to most forms of borrowing, including credit cards, unsecured personal loans and mortgages.

It’s true that taking out credit will cause your score to dip in the short term, but lenders (and therefore credit agencies) really like to see borrowers who have shown that they can use credit responsibly and repay it.

However, that last part is important – failing to make repayments is a surefire way to seriously damage an otherwise good credit report.

One exception here – payday loans (short term, high-cost loans – defined by the FCA as having an APR above 100% and a repayment term of less than one year) have all sorts of drawbacks, not least the high interest rate. However, they also tend to look bad on your credit history, even once you’ve paid them off, as they’re seen as a sign of poor financial management.

For more on this topic, we have a full guide to how personal loans affect your credit score.

Allows you to consolidate debt

Personal loans can be an effective way to consolidate debt.

Debt consolidation is a way to bring together multiple, expensive forms of credit into one monthly payment, and save money in the process.

We’ve covered debt consolidation loans in much more detail here, but in short, a personal loan is one of the most common and effective ways to do it.

No collateral for unsecured loans

We’ve covered this briefly above: unsecured personal loans don’t require you to use your home as security, which means you face less risk as a borrower. That being said, a loan is not something to take lightly, with or without security, and you should always make sure that you’re able to repay any credit you take out in full and on time and consider what would happen if your circumstances were to change.

Pay it off over a fixed period

A personal loan is set up to be repaid. You know exactly how long it will take to repay a loan, and you make fixed payments until you’re done. That means that it doesn’t take excessive self-discipline to get yourself out of debt – you just need to make the monthly payments over your agreed loan term.

This is an advantage over credit cards, where it can be very tempting to roll over balances from month to month, making only the minimum repayment, moving to a higher interest rate and remaining in debt.

What are the disadvantages of personal loans?

Personal loans aren’t without their disadvantages though – in this section, we’ll cover some of the arguments against personal loans so that you can make a balanced decision.

Interest rates can be high

Personal loans certainly aren’t the most expensive form of credit out there, but they’re not the cheapest either.

The interest rate you pay will be heavily influenced by your credit score, but it’s likely to be at least 8% for less than £5,000 (much lower interest rates are available for higher balances).

That compares well to credit card debt, but if you’re buying something specific (such as new furniture), you may find that the store is able to offer credit at a lower rate (for example, IKEA, Argos and John Lewis all offer 0% credit in some cases. As always, it’s worth looking around – including at other forms of borrowing – to make sure you’re getting the best deal.

Some personal loans come with extra fees

Although it’s rare, some lenders do apply compulsory fees for unsecured personal loans, on top of interest.

At Koyo, we pride ourselves on having no hidden fees and allow you to settle early at any time with no penalty.

You need to make fixed payments

Fixed payments can be a blessing, but they can also be a challenge. We explained above that fixed payments are useful because they help you to get out of debt on schedule. However, it’s worth noting that sometimes, a little extra flexibility can be helpful. For example, with a credit card, you can vary your monthly payment (although paying off debt more slowly adds significantly to the total interest you’ll pay).

Not paying them back can increase your debt

Obvious, but worth re-stating – if you borrow money, you’ll have to pay it back – and failing to do so can have serious repercussions. One additional issue is that many lenders charge a fee for missed payments, adding to your debt.

As we’ve explained above, when borrowing money, you should only borrow what you can afford to repay – and you should consider how you would handle a change in circumstances, such as losing your job or having a baby.

Larger loans may require security

The vast majority of personal loans are unsecured (and that includes Koyo). However, if you’re looking at much larger loan amounts (typically above £20,000), you might need to consider a secured loan. This allows lenders to get comfortable with loan sizes in the tens of thousands, but the catch is that your home is at risk if you fail to make repayments. Naturally, you should think very carefully before taking on any secured debt.

It’s worth keeping in mind that personal loans aren’t for everyone. With this in mind, we’ve put together two further guides, the first covering common reasons for personal loan rejection, and the second providing tips on how to get approved for a personal loan.

What are some alternatives to personal loans?

The most obvious alternative to a personal loan is a credit card. Rather than borrowing a fixed amount and repaying it according to a schedule, a credit card allows you to spend up to a certain limit and choose how much to repay each month (above an agreed minimum payment).

If you pay the balance off in full, you won’t pay any interest. If not, you’ll pay interest on the outstanding balance – typically at a higher rate of interest than you would on a personal loan.

Other alternatives include store credit, which varies depending on where you’re buying from, adding to your mortgage, and – in the case of cars – specialist forms of finance such as HP and PCP agreements.

Conclusion: Weighing the pros and cons of personal loans

Hopefully, you’ve found this article useful. To summarise here’s a very high-level reminder of the pros and cons of personal loans:

Pros	Cons
Clear and simple to understand Fairly flexible Relatively cheap Designed to be repaid on schedule (getting you out of debt)	Less freedom to vary your monthly payment Other forms of credit may be cheaper, depending on your circumstances

As a reminder, if you’re looking for a flexible personal loan of £1,500-12,000, you can take a look at our loan calculator or make an application at www.koyoloans.com (Representative 27% APR).

Lastly, we’ve answered some of the most commonly asked questions about personal loans below – but if there’s more you’d like to know, leave a comment below!

Frequently asked questions about the pros and cons of personal loans

Is taking out a personal loan worth it?

There’s no one-size-fits-all answer, and the article above is designed to help you to make your own decision. However, a few questions to ask yourself before taking on any credit would include:

• Do I need the loan in the first place? (e.g. could I defer the purchase, or avoid altogether)

• Is there another form of credit that would be cheaper?

• Can I comfortably afford repayments – even if my circumstances change?

What are the main disadvantages of personal loans compared to credit cards?

The main disadvantage of a personal loan relative to a credit card is the reduced flexibility. With a credit card, you have a lot of control over how much you repay each month (although that control comes with a price – you’ll pay much more in interest if you don’t repay the full amount right away).

That being said, the disadvantage is also an advantage – the fixed monthly payments can help you to budget, and sticking to them will get you out of debt on schedule rather than rolling it over.

For more on this, take a look at our full guide: personal loans vs. credit cards.