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Personal Loans
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Overview
If you need to additional money to start a business, to consolidate your
existing debts, to buy a car or to pay for a holiday, a personal loan might be
the answer. Every bank and building society has different lending
criteria so it is important to investigate multiple options to ensure
that you receive an loan that fits your needs. Many lenders specialize in loans
to individuals with bad credit, so you might be able to get a loan even if
you have declared bankruptcy or have county court judgements against you in the
past. Personal loans can have a variety of structures. The key features of a
personal loan are:
- The security required for the loan
- The interest rate (or APR)
- The repayment schedule
Types of Loans
One of the most important distinctions between different types of loans is
the security required by the lender. Security refers to the collateral offered
to the bank to lend money against. If you fail to repay your loan in the timely
fashion, the lender will have the right to seize your collateral and sell it in
order to repay the loan. High-quality collateral reduces risk to the lender and
often results in a lower rate of interest on the loan. Individuals who have
declared bankruptcy or otherwise have poor quality credit often find it
impossible to borrow money without offering high-quality collateral as security
on the loan.
Unsecured Loans
Unsecured loans are loans made to individuals which do not require any form
of collateral since the credit quality and financial position of the individual
is sufficient for the lender to extend credit without collateral. Most lenders
limit the size of the unsecured loans to less than £15,000 or £25,000 without
special credit approval.
Secured Loans
Most secured personal loans use excess equity in your home or other property,
as collateral but other types of assets might be acceptable. Home equity is
difference between the value of your home and amount of mortgage outstanding on
it. Your home will be at risk if you fail to make repayments on loan, which
uses your home as collateral.
Secured Loan |
Unsecured
Loan |
Requires collateral, usually your home,
which will be at risk if you fail to make
repayments |
Requires that the credit rating and financial
position of the applicant is such that no
collateral is required. |
Can often be used for any purpose |
The lender might restrict the loan to explicitly
exclude certain purposes (e.g. to start a
business) |
Loan amount could be limited by the value
of your collateral (e.g. the value of your
home will limit the amount of the loan you
can secure on it). |
Most lenders limit unsecured loans to less
than £15,000 or £25,000 |
Is often cheaper than an unsecured loan |
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Interest Rate
An interest rate is the amount charged for a loan. It is usually expressed as
a percentage of the loan amount that is charged on an annual basis. Because
lenders often calculate interest rates differently, statutory regulations
set out the calculation for the Annual Percentage Rate of charge (APR).
The APR is the true rate of interest charged on a loan taking into account
the total cost of interest and other charges (e.g. broker's fees / legal
fees). The APR is intended to give consumers a level playing field to compare
personal loans against each other. For information on how the APR is calculated,
please refer to the website of the Office of Fair Trading (http://www.oft.gov.uk/).
Repayment Schedule
The repayment schedule on a loan stipulates the length of time over which the
loan will be repaid and frequency of the payments. Together with the interest
rate, this information determines the size of the loan repayments. For example,
if you wish to borrow £5,000 over 3 years at an APR of 9.7%, the monthly
repayments will be £159.77 and total repayment over the loan term would be
£5,751.70.
Credit Insurance
Credit Insurance is an insurance policy that continues the repayments of a
particular debt in the event of the policyholder becomes financially unable to
do so because of illness, death, redundancy, or any other specified cause.
Most lenders offer credit insurance on their personal loans and include the
premiums on the insurance as part of the monthly repayments on the loan.
Credit insurance is not included in the calculation of APR so a loan with or
without credit insurance would have the same APR but different monthly
repayments. For example, if you wish to borrow £5,000 over 3 years at an APR of
9.7% without credit insurance, the monthly repayments will be £159.77 and total
repayment over the loan term would be £5,751.70. This same loan with credit
insurance would still have an APR of 9.7% but the monthly repayments would be
some amount higher than £159.77.
Early Repayment
Penalties
Some lenders levy penalties if you choose to repay the loan before its final
maturity date. You should carefully investigate these charges if you think that
you might want to pay the loan back early.
Glossary
Annual Percentage Rate (APR) - The APR is the true
rate of interest charged on a loan taking into account the total cost of
interest and other charges (e.g. broker's fees / legal fees).
Collateral - Assets pledged as security for a loan.
In the event that a borrower defaults on the terms of a loan, the collateral may
be sold, with the proceeds used to satisfy any remaining obligations.
Secured Loan - A loan with assets (usually, home
equity) pledged as collateral. The value of the collateral mitigates the lenders
risk.
Unsecured Loan - A loan without any collateral which
depends on the credit history and financial position of the borrower.
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