Personal loans: a guide

A personal loan can be a convenient way of raising funds, whether it's to fund home improvements, a course or a holiday. But there are a few things to consider before you take out a personal loan. Here we take a look at the different types of personal loan, and which is best suited to each person's situation.

Secured personal loan

A secured loan has ‘collateral' secured against it, in the form of personal ‘assets' (usually your home, but it can potentially be any item of higher value than the loan, e.g. a car). When you take out this type of personal loan, you will make an agreement that should you fail to make repayments, the lender will be allowed to repossess your assets to make up their losses.

Because there is a lower perceived risk to the lender of losing their money, secured loans often carry lower interest rates, and the maximum amount you are able to borrow is usually higher and over a longer term than unsecured loans. Repaying the debt for longer may mean paying more interest in the long term.

Unsecured personal loan

Unsecured loans are widely considered a ‘safer' form of personal loan, because they do not have any collateral secured against them. Instead, the lender will put trust in your ability to repay the loan, based on your credit rating and salary.

Because there is no collateral secured against this type of personal loan, you are at less risk of losing personal belongings should you run into trouble with repayments (although you will still be liable to face legal action).

The downside of this is that if you are borrowing higher amounts, the interest rate is likely to be higher than with a secured loan, and the amount you can borrow may be limited.

However, for borrowing smaller amounts over shorter repayment terms, the difference in interest is often negligible – so the security of an unsecured loan may be more appealing.

Which type of personal loan should I choose?

As with most financially-related things, it depends on your situation, and how much of a ‘risk' you are willing to take.

Secured loans are only usually available to homeowners. However, many homeowners still opt for the ‘safe' option of an unsecured loan, as it does not carry the risk of losing collateral.

Tips for choosing a personal loan

•  Shop around. Many people automatically go with their current account or savings account providers when choosing a personal loan, but it's possible to save a lot of money in the long run by shopping around for personal loan deals with lower interest rates.

•  Only borrow what you need. It's tempting to borrow extra money on your personal loan to fund unnecessary purchases, but the more money you borrow, the greater the risk of running into trouble with repayments.

•  Plan ahead. Personal loans can be repaid over the course of several years (usually up to 25 years, but 2-5 years is more common). With this in mind, plan ahead, and be sure that you can make repayments for the full period.

•  It's impossible to predict exactly what might happen to your finances in that time – you might be made redundant, or fall ill – so it often makes sense to consider taking out PPI (Payment Protection Insurance) on your personal loan

Think Money offer a range of loans to suit various financial situations. If you are thinking about taking out a loan, contact one of our expert advisers now.