What Type of Loan is Right for You?

If you're confused, this article will help you to get clarity on your optimum loan…

Updated: May 21, 2024
Matt Crabtree

Written By

Matt Crabtree

|
Rebecca Goodman

Edited By

Rebecca Goodman

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There are lots of reasons why you may need a loan, from paying off a debt to paying for a big expense such as a new car or a home improvement project.

The personal loans market is huge and very competitive, so there are loans for anyone – for any reason. But it's important to compare loans and to shop around, as there are also interest rates and fees to factor in.

If you need some help deciding which loan best fits your requirements, here we discuss some of the most popular reasons for taking out a personal loan, how they work, the pros and cons, and pick out some of the top picks to choose from.

First, what is your reason for borrowing?

They type of loan you need will usually be determined by why you need the money and what you plan to do with it. You will also need to think about how long you need the money for, and when you will be able to pay it back.

Borrowing for a vehicle or a house, for example, is quite different to taking out a loan to finance a holiday (Read more in our: Best Budgeting Apps guide).

You may need a loan for the following reasons: 

  • A new car
  • A home purchase
  • Consolidating debts
  • A wedding
  • Making a big purchase
  • Budgeting for a trip
  • Renovating your house
  • Creating a new company

Next, choose the type of loan you need

There are lots of choices when it comes to personal loans, and the first is to decide which type of loan you need.

There are a few main types of personal loan, including home-owner secured loans, personal unsecured loans, guarantor loans, and payday loans. The best loan for you will depend on things like the amount you want to borrow, your income, and your credit score.

You will also want to factor in the risk of the loan. This relates to secured loans, whereby you need to put up an asset as collateral against the loan. If you're unable to make the repayments, the asset – which could be your home – can be seized by the loan provider.

Here we've listed the four most common types of loan, and how they work in terms of the amount of money you could borrow and how long you would repay it for. We haven't put in the interest rate or any other repayment terms in this table though.

Loan typeUsual amountUsual repayment length
Homeowner (secured) loan£3k to 25k3 to 25 years
Personal (unsecured) loan£0.5k to 25k1 to 7 years
Guarantors loan£1k to 10k1 to 5 years
Payday loan£100 to £5k 1 week up to 3 months

Your name, home address, birth date, and some basic financial information are all that will be usually required when comparing loans. Popular comparison tools will rank over 20 different lenders, which can include online brokers, to find the best loan for your needs. They are a quick and easy way to compare loans, and most will carry out soft searches of your credit score, which won't impact your score negatively. They can then show you the loans you are most likely to get approved for. 

1. Should you get a secured loan?

Should I choose a secured loan, and what does it mean? 

You can get a loan that is secured against an asset, most often your house, by applying for what is called a secured loan, homeowner loan, or second-charge mortgage.

Interest rates for these loans are often lower, resulting in cheaper monthly payments. The overall amount you pay back (with interest) throughout the life of the product, however, may be much greater because of the often much longer repayment period. You should also consider whether or not you can afford the monthly payments, since failing to do so might result in losing your home (or whatever other asset you've put up against the loan). 

If you take out a secured loan, you're promising to the lender that, in the event you stop making payments on the loan and go into default, they may sell or otherwise take possession of an asset of yours. The term “security” refers to the item pledged. When they repossess the security you've pledged, they'll sell it to pay off the debt you owe. 

A mortgage is the most common kind of secured borrowing. Mortgages are one kind of collateral, but there are other options as well. Pawnshop loans are secured by personal property, such as jewels, whereas logbook loans are secured by the borrower's vehicle.

If you want to borrow more money, you will have a better chance of getting a loan if you present something as collateral for the loan. What's the rate and term of this loan?

Loan typeUsual amountUsual repayment length
Homeowner ‘bridging’£5k to 250mMax of 18 months
Personal for home improvements£1k to 25mMax of 25 years
Debt consolidation£10k to 25Max of 35 years
VehiclesCost of vehicle Max of 5 years
Logbooks£500 to £150k Max of 5 years

Why a secured loan is preferable?

Because the lender is taking on less risk, the interest rate is usually cheaper than with other types of borrowing. You may borrow a bigger amount if necessary. If you take out the loan with your current mortgage lender, it can be simpler to handle the repayments because it is all in one place.

Why a secured loan can have drawbacks?

If you can't make your payments, you could lose your house (or whatever collateral you used to secure the loan), you could end up paying more in interest over the life of the loan, the application process could take longer to complete because a valuation of your property or collateral is required, and you could be subject to an early repayment charge.

2. Is an unsecured loan a better option?

An unsecured loan, often known as a personal loan, is not tied to any specific property as a secured loan is. The application procedure is simple, and the funds may be deposited in your account quickly. You may not be able to borrow as much though, and the interest rates are significantly higher. 

Your real annual percentage rate (APR) may be higher than the sample APR shown in advertisements since it is based on your individual circumstances, which might result in higher monthly payments. When compared to a secured loan, the total amount repaid is often less for an unsecured loan borrower since interest is accrued over a shorter period of time. 

Even if your house is safe from foreclosure, you still need to be sure you can afford to make the monthly payments or you risk damaging your credit score. Future access to other types of financing will be severely hampered as a result of this. You may get the money you need without risking your goods or assets by opting for an unsecured loan.

Borrowers in the UK may choose from seven different forms of unsecured loans, each of which is available for a different maximum loan amount and repayment term.

Loan typeUsual amountUsual repayment length
Bad credit £1k to 25k1-5 years 
Guarantors£1k to £40k1-5 years 
Consolidating debt£1k to £40k1-10 years 
Peer to peer £1k to £30k0.5-5 years 
Personal £500 to £25k1-5 years 
Payday Max of £1,000Up to a month
Short-term £500 to £2.5kUp to a year

Why would an unsecured loan would be preferable?

There is less risk than with a secured loan because there is a lower chance of losing your home if you don't keep up with repayments. There is usually no early repayment charge, so you can pay the loan back as quickly as you like. The payments are consistent and easy to budget for because the interest rate is usually fixed.

Why it's not a good idea to get an unsecured loan?

Unsecured loans often have a larger monthly repayment than secured loans, and borrowers with low credit histories may be ineligible for unsecured loans altogether.

Which one is better?

There are pros and cons of secured and unsecured loans and the best for you will depend on how much you want to borrow, over what term, and how you can repay it. Your credit score is also an important factor.

You also need to make sure you can repay any loan you take out. This is vital not just for the lender's sake, but also for yours. If you take out a loan that is too large for your budget, you may have trouble making repaying it. For an unsecured loan this could result in damaging your credit score and for a secured loan, you could lose your home in the worst-case scenario.

3. How about guarantor loans?

What exactly is a guarantor loan and should I get one?

Simply put, a guarantor loan is a personal loan in which another responsible adult (often a family member or a friend) agrees to assume responsibility for the loan's repayment in the event you are unable to. 

It's something to consider if you have a spotty credit history or no history at all since you've never signed any credit agreements in the past. It means you may apply for a loan again even if you've been turned down in the past. 

What are the benefits of a loan with a guarantor?

When you take out a personal loan with a guarantor, that individual guarantees to make the payments in your place if you are unable to. Interest rates may be more reasonable than for borrowers with bad credit since the lender has collateral to guarantee repayment.

What are the drawbacks?

The guarantee must have faith in the borrower's ability to make payments and the guarantor's role must be limited to that of an insurance provider. The person who is going to act as a guarantor needs to have a good credit rating in order to be accepted in the role. They also need to fully understand the role they are taking on. If you're unable to make repayments on the loan, it would fall to them to cover these costs. If they're unable to, they could lose an asset they own – such as their home.

Getting a guarantor

It's important to verify a guarantor's details before including them on an application. Given the scope of the project, they should have solid financial standing and a significant amount of equity in their property (at least 50 per cent). If you wish to borrow money in this manner despite your poor credit, your guarantor should be able to attest to your reliability. 

You may be able to borrow money even if you've been turned down for loans in the past. The interest rate is often much lower than it would be with an “impaired credit” loan.

4. Are payday loans your only option?

Can I benefit from a payday loan, and what exactly are they?

Payday loans, also known as short-term or cash advance loans, are often not the ideal financial solution for anybody. Despite the fact that they are subject to stricter regulation than they used to be, they still carry a high risk that anyone taking one out will end up in serious financial debt.

Payday lenders are notorious for charging outrageous interest rates, often as high as 500%. Despite the fact that many of the industry's big players have gone out of business, payday loans are still widely accessible.

Whether or not this is a good thing is highly debatable. Payday loans still have a place, but only in very rare circumstances when the loan amount is modest and is repaid rapidly.

Drawbacks of getting a payday loan

Payday loans may have major repercussions, including substantial damage to your credit rating if you are unable to make your repayments on time. This can make it difficult, if not impossible, to get future credit, such as a mortgage.

Our article “Where to get free debt advice” includes resources to aid those who are having trouble keeping up with their financial obligations. Read our article “What is the best way to consolidate my debt?” for more information. 

Before choosing your loan…

What kind of loan will best suit my needs?

Asking yourself the following questions will help you make a well-informed decision:

1. How much money do I need? 

A secured loan often allows you to borrow more money and have lower monthly payments, but the loan's duration is typically longer and the total amount paid in interest is usually higher.

Secured loans typically start at around £10,000 but may be as little as £3,000. We address why a credit card might be a better option than a loan if you need to borrow a smaller amount of money later in the article.

2. How long will I have to make the repayments?

Paying back a larger sum over a shorter period of time can reduce your interest costs. This is the case if you have the financial flexibility to do so. You don't have to put up your house as collateral for an unsecured loan, so it's a safer option if you can afford it.

However, you should think about how much you can afford to pay back every month, since falling behind on payments might harm your future borrowing opportunities.

Is your credit in bad shape? If you answer “yes”, you may be forced to take out a secured loan at a higher interest rate or, if you can't locate a cosigner, a guarantor loan.

When you've settled on a loan and want to apply, check out our article “How to Apply for a Loan” for tips. If you need a smaller amount than £3,000, you may want to consider a balance transfer or money transfer credit card arrangement as an alternative to a loan.

If you are diligent and able to repay the loan in full before the conclusion of the interest-free term, you will have additional options for handling your debt. 

Instead of getting a loan, you may save up the money you need over time. Check out our savings best purchase tables and review of the top UK savings apps to begin started, or use a budgeting app (there are reviews of some of the finest in that post).

How lenders decide… 

What factors do lenders consider when deciding whether or not to provide a loan? There are a lot of criteria that will determine how much you may really borrow, including:

  • the present state of affairs in terms of money, especially monthly spending capacity
  • details on your credit history and
  • the reliability of your family's financial situation (top savings accounts)

Some lenders may be willing to cooperate with you while others could say no if they determine that you are applying for a loan amount that is outside of your financial means.

Bad credit loans, payday loans, short-term loans (sometimes known as instalment loans), guarantor loans, and logbook loans are just some of the specialised financial products available to individuals with low credit histories. The interest rate on these loans is greater, so borrowers know they'll have to pay more back.

Having a solid credit history will open up more options for you when it comes to loans, and the interest rate you'll pay will be cheaper as a result. Learn how to improve your credit rating.

Why do most people take out loans?

People seek loans for a wide variety of reasons. Having enough money in the bank to pay for emergency needs such as a vehicle repair, boiler replacement, or medical bill is important to some more than others.

For others, it may be in order to pay for far more extravagant things like a new automobile, a renovation to their house, or the trip of a lifetime.

Having debt isn't always a negative thing until it becomes unmanageable or prevents you from providing for yourself and your loved ones. You should only decide to get a loan if you have a reliable source of monthly income and can commit to paying back the principal and interest on time every month for the life of the loan.

Where you reside in the nation might affect how much of a loan you will need to take out. Borrowers in London often pay higher interest rates for home renovation loans than borrowers in Scotland. You should always go with the lowest price offered by a service provider, and you should look around for the best financing option.

Summary…

Loans can be a handy financial tool for getting access to cash. Whether it's a new car or a DIY project, you can take out a loan and if approved can get the money to pay for your expenses.

However, they're only a good option if you can comfortably repay them and you fully understand the consequences if you're unable to repay.

You'll also need to look carefully at the APR so you know exactly how much you're being charged for taking out the loan.

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