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A personal loan is one of the simplest ways to borrow money.

You borrow a specified amount from a lender, and pay it back bit by bit over an agreed period of time. Because they are so straightforward, personal loans are very popular, and many borrowers will find that they have numerous options available to them.

We’ve written this post to help you understand personal loans in the UK, and give you the information you need in order to choose the best option for you. 

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%

How do personal loans work?

A lender - such as a bank, financial firm, or credit union - agrees to lend you money.

You repay that money, plus interest, over an agreed amount of time (called a term, usually a fixed term). Once you’ve made all your loan repayments, that’s it - the loan is paid off.

That makes it different to a credit card or a current account overdraft: these products are designed to be dipped in and out of, with more flexibility and no fixed term

There are lots of different types of loans, but personal loans are a relatively cheap and predictable form of borrowing.

image explaining how personal loans work

Secured vs. unsecured loans

Personal loans are generally unsecured.  What does that mean?

  • Secured loans are secured against an asset, typically your home. That means that if you fail to make repayments, your lender could take control of it and use it to make a recovery, interest rates are usually lower
  • An unsecured loan doesn’t have this protection for lenders. For borrowers, that’s a good thing - you don’t have to put an asset at risk

Mortgages and home improvement loans are common forms of secured lending. In this article though, we’re covering unsecured loans. These are usually for smaller amounts (in the thousands), repayable over a few years, with a fixed rate of interest.

Is it a good idea to get a personal loan?

As with any form of credit, it depends on how you’ll be using it. Personal loans are generally used for one of two purposes:

  1. To spread the cost of a large purchase out over a longer period of time
  2. To consolidate multiple forms of outstanding debt

We’ve covered debt consolidation loans in lots of detail elsewhere, so we won’t go into it here, but debt consolidation can be an effective way of managing other, expensive forms of borrowing.

A personal loan is a relatively cheap way to borrow money, but of course it isn’t free. To minimise your costs, you should borrow only when necessary, and when you do borrow, you should borrow as little as possible and pay it off as quickly as possible.

You should only borrow if you’re confident of your ability to repay - missed payments can cause serious problems, and will make it very hard for you to access credit in the future.

What is the term on a personal loan?

Most providers allow you to be extremely flexible when deciding over what term you want to repay a loan. Loan terms are usually at least 6 months, and can be as long as 5-10 years.

Of course, a longer loan term will mean that it takes longer to repay a loan, but it may also affect the interest rate (or APR) that you pay. Some lenders increase or decrease the rate you pay depending on how long you’re borrowing for.

Most modern lenders have a loan calculator on their homepage. This allows you to vary the amount and length of time of a loan, to see how your monthly payments would be affected. 

As a rule, you should aim to pay off debt as quickly as possible. By doing this, you’ll minimise the total interest you’ll have to pay 

Related post: Thinking about taking out a personal loan to pay for a holiday? Our guide summarises 4 different ways of how to pay for a holiday including cash, credit cards, and personal loans, helping you to make the best decision.

Can I get a personal loan even if I have a bad credit score?

Most personal loan providers look at credit scores when deciding whether to offer someone a loan, or calculating an interest rate. In general, if you have a poor credit history, you’ll find it harder to access credit, you might be able to borrow a lower total amount, and may face higher interest rates.

By contrast, if you have a good credit score, you’re likely to be able higher loan amounts and at lower interest rates.

However, it’s important to note that your credit score is only one factor in your overall credit report, generally used as a simplified measure. You can read up about about what credit score you need for a personal loan here.

Not all lenders use credit scores, either. Lenders that use Open Banking use customer data: with the borrower’s permission, they can look at income and expenditure to get an accurate picture of how affordable a loan is (for more information, take a look at our guide: Open Banking explained). Another alternative is to find a credit union, which may have different eligibility criteria.

What are the risks of a personal loan?

When you enter into a personal loan agreement, the terms of the loan are fixed. You know precisely how much you’re borrowing, what rate of interest you’ll pay, and how long you have to pay it back. That makes it relatively safe: unlike, say, a tracker mortgage, the rate won’t change part way through the life of the loan.

So, the most notable risk associated with a personal loan is a change in your own circumstances. A significant life event could affect your ability to repay a loan. A few examples of significant life events are:

  • Having a child
  • Losing your job
  • Moving house
  • Starting a new business

The good news is that a borrower with an unsecured personal loan has a relatively high degree of protection. Unlike with a secured loan, such as a mortgage, an unsecured personal loan does not put your house at risk.

However, failing to make regular monthly repayments in full is a serious problem - you are likely to have to pay a fee, and it will do serious, lasting damage to your credit score. You should only borrow what you believe you’ll be able to repay in full. If you’re struggling with debt, National Debtline has lots of free resources.

What if my personal circumstances change?

If your personal circumstances change (for example, if you lose your job due to coronavirus), you should speak to your lender – there are payment holiday options that can help. If you do need to take a payment holiday, it should not appear on your credit report (1), but you’ll still be charged interest for that period and it will take longer to repay in full.

If you’re having longer term problems with debt, then it’s a good idea to seek help. Again, the National Debtline is a good place to start.

Do personal loans hurt your credit score?

Taking out a personal loan - or any form of credit - might have a small negative impact on your credit score in the short term. That’s generally because when you apply for a loan, a lender might carry out a credit check, which leaves a mark on your credit history. It’s also possible that a lender might not want to offer further credit to someone who already has one loan to service.

However, one of the most effective ways to build up a positive credit score is by making regular repayments on existing debt. So, over the long term a personal loan can have a positive impact, so long as you make the scheduled repayments in full.

What are the pros and cons of personal loans?

Relative to credit cards, here are the pros and cons of personal loans:

Personal loan

Credit card

Fixed amount

Flexible, with a set credit limit

The rate you pay is fixed from the start and won’t change

You might benefit from an introductory offer, but interest rates can then increase sharply

You can often repay the outstanding balance with no extra fees, but not all lenders allow this

You can always repay the outstanding balance with no extra fees

Typically cheaper than a credit card

Typically more expensive than a personal loan

Should you take out a personal loan to pay off credit card debt?

A debt consolidation loan can be an effective way to pay off expensive credit card debt. If you’re interested, we’ve written a detailed guide to the best ways to consolidate credit card debt.

Can I pay off a personal loan early?

Yes. Lenders will often allow you to repay a loan early, although it’s worth noting that there may be a fee payable if you do so. Lenders should make this clear to you, but if you’re in doubt, just ask.

How do I choose a personal loan provider?

You’ll find that there are lots of different providers to choose from, including banks, building societies, credit unions and independent lenders.

A good place to start is with a comparison site - this will give you lots of options, some representative examples, and an idea of what you might expect to pay. You’ll usually be quoted an annual percentage rate, or APR, which is a good way to compare the total cost of borrowing (we’ve also put together a useful guide to APRs and what they mean).

You should also shop around - many lenders don’t feature on comparison sites, so it’s worth making sure that you’re not missing a good provider, particularly if you have a poor credit rating.

Once you’ve found a good provider, you can make a loan application. If successful, you’ll set up repayments and once approved, you’ll receive the money in your bank account - sometimes in less than a day.

We wrote an article where we look at how lenders decide who to lend to, and how you can maximise your chances of getting approved for a loan.

Now that you’ve read our article on personal loans, you might want to take a look at some of the options available to you. Our loan calculator is a great place to start.

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