Guide to loans
There are two main types of loans: Secured and Unsecured. The former meaning that the money borrowed is secured against collateral, whether it is a house or a car, while the latter does not require any security.
However, loans aren't quite that simple. There are many more different types of loans within these two groups. The type of loan someone has may depend on the term, the amount available to borrow, the interest rate, where the money comes from, what it can be spent on and so on.
This guide will explain some of the most common loans available on the market, making it easier for people to choose the borrowing that is right for them.
The most common type of loan is the unsecured personal loan. It is traditionally available from banks and building societies. It is up to the borrower to decide how the money is spent, provided it is legal.
The borrower will decide the amount they want to borrow and how long for within the parameters set out by the lender – usually between £1,000 and £25,000 and between one and seven years. The loan is repaid in regular monthly instalments, which contain both the capital and the interest, meaning the debt will be cleared by the end of the term.
In contrast to a personal loan, a home owner loan is secured against property by way of a 'second charge'. This comes second to your mortgage – first charge – and is a legal arrangement registered with Land Registry.
Again, the funds can be used for any legal and non-commercial activity; although they are most commonly used for large purchases, such as home improvements or a new car. Homeowner loans work in the same way as personal loans, but borrowers can access up to £250,000 over a period of between five and 25 years.
Traditionally, loans are available from banks and building societies, but another type of borrowing hit off during the recession: social or P2P lending. Rather than borrowing from an institution, people borrow from other people. This has benefits for the borrower: cheaper borrowing, and the lender: higher rates of return.
P2P lending is done through websites that match lenders with suitable borrowers. However, most loans will be contributions from a high number of lenders, not just one. This means if the borrower does default, one person hasn't lost a significant amount of money. Lenders are often available to choose how much risk they are willing to take – as the rewards are higher.
Another product of the economic downturn is the payday loan. They are quick and convenient; designed to bridge the gap between running out of money and when wages are due to be paid. This is a short term loan, usually available for up to 30 days, but it is does depend on the lender. Payday loans are used for much smaller sums of money, often between £100 and £1,000.
Payday loans have a bad reputation because of incredibly high APR they charge borrowers – often in excess of 5,000%. While this does work out to be very expensive, it's worth noting that payday loans are not available for the long-term, making an annual percentage rate useless. It is better to compare the cost per £100 borrowed.
While payday loans have been around for many years, the squeeze on incomes combined with a flurry of online providers has made them much more commonplace in the past five years. The money can be used for anything, but is often used for emergencies and unexpected bills, such as car repairs.
This type of loan is used to consolidate a number of outstanding loans and other debts into one monthly payment. The funds are used to repay existing debt and are often paid directly to the lenders so the cash cannot be used for other purposes. The borrower will end up with a single monthly repayment to the new lender.
The advantages of doing this are not only ease and convenience, but it can also work out much cheaper – especially if previous debts had high rates of interest. Most debt consolidation loans are secured for the sole reason that a person requiring consolidation is likely to have fallen behind with repayments – affecting their credit score. It is far easier for a person with a poor score to be accepted for a secured than an unsecured loan.