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What is a loan?

A loan allows you to borrow a sum of money, which you pay back in instalments – usually with interest – within a certain timeframe.

A loan can help you cover the cost of a large expense. The amount you’ll be able to borrow and the interest rate on offer will depend on a number of things, like your credit score and how long you’ll take to repay it. 

Here, we look at:

Reasons to get a loan
What are the different types of loans?
Is a loan or credit card better?
Things to consider before taking out a loan
How to apply for a loan
What happens if you can’t repay a loan?
Can you pay off your loan early?

Reasons to get a loan

There are lots of reasons people take out loans. For example:

What are the different types of loans?

When researching borrowing options, you may see products described as either secured or unsecured.

A personal loan is the most common type of unsecured loan, which you can use to cover the needs above. Unsecured loans tend to be for smaller amounts and aren't tied to an asset.

Secured loans tend to be larger and require an asset for security – such as a house. For example, a mortgage is a type of secured loan because the lender is able to sell the property if you’re unable to meet the repayments.

Other types of loans include credit union loans, payday loans and peer-to-peer loans.

Is a loan or credit card better?

Depending on what you need to borrow money for and how much you want to borrow, you may want to compare loans and credit cards

Both work in a similar way – you borrow money and pay it back. But there are pros and cons to each, so weigh up which might be right for you.

Credit cards can be better if you need to borrow small amounts on a regular basis. They’re useful if you’re unsure how much you need to borrow, or just want to have extra funds available in case of an emergency. 

Loans tend to be more suitable for borrowing a larger amount of money, over a longer period of time. You may be able to get a better interest rate with a loan and you’ll have a set repayment term. 

Whether you choose a credit card or loan, it’s important that you can afford to repay the money you borrow. You may have to pay a fee if you miss a repayment and your interest owed can start to build up. This can also have a negative impact on your credit score and your ability to borrow in future. 

Explore: Ways to borrow

Things to consider before taking out a loan

Check the interest rates available, to find the best one for you

This will often be expressed as an Annual Percentage Rate (APR). You may be shown the ‘representative APR’ when searching for a loan. This isn’t necessarily the APR you’ll receive – it’s an example, so you can quickly compare the potential cost of the different loan products you may be eligible for.

The APR you’ll get is based on your individual circumstances, so this may be different to the representative APR advertised. Always read the terms and conditions of any products you’re offered.

Make sure you can afford the repayments

Creating a budget can help you see if you can afford the repayments. If you’re unable to make the repayments, you may want to consider other options like borrowing less or saving up instead. By delaying a purchase, you may be able to save up the full amount you need, or a good proportion of it, so you’ll need to borrow less.

Check and improve your credit score

Before a bank or financial lender offers you a loan, they’ll most likely check your credit score. This shows them how reliable you are at borrowing and repaying money.  

It’s a good idea to check your credit report and try to improve your credit score before you apply for finance. Your credit score can impact whether you’ll be successful in a loan application. 

A better credit score can also lead to you being offered better interest rates, as well as the choice from a wider range of loan products.

Try not to apply for multiple loans at the same time

Lenders will do a hard credit check, which leaves a footprint on your credit file. Lots of hard credit searches in a short period of time may signal to a lender that you’re struggling to manage your money. This may impact your credit score and determine whether or not you’ll be successful in a loan application.

How to apply for a loan

Applying for a loan should be done carefully. Make sure you’ve found the right loan for your circumstances and you have all the correct documentation. This may include:

  • your personal information
  • your bank details
  • your employment details
  • proof of address and previous addresses

Check with the lender to see if there’s anything else you may need – such as a P60 or any other official documentation. It can help the application move quicker if you have everything you need to hand.

If you’re applying for a loan with your existing bank, the process may be much simpler as they’ll already have a lot of your information on record. You may be able to do this in a matter of minutes online or through an app, which is why it’s so important to think through everything before applying.

Once you’ve completed your loan application, check it thoroughly before you submit it.

Explore: What to check before applying for a loan

What happens if you can’t repay a loan?

Keeping up to date with your repayments is important – to help you manage your money and avoid fees. When applying for a loan, check and make sure you’re able to afford the repayments by including them in your budget.

You may want to set up a Direct Debit so the repayments are made automatically. Check your account regularly to make sure there’s enough money to cover them. 

If you’re unable to make a repayment, speak with your lender as soon as possible. They may be able to help find a solution. Falling behind on debt repayments can put you in arrears (where you owe money that should have already been paid), which can be difficult to get out of. It can also negatively impact your credit score.

Can you pay off your loan early?

If you can afford to, you may want to look at making overpayments on your loan. It’s not essential to do this, but it can help you pay your loan back quicker and save you money in interest payments.

There may be a fee for making an overpayment so check with your lender before you do. 

Explore: How to manage your loan repayments