Excerpt: Find out everything you need to know about loans and how they work
A loan is an agreement where a provider lends something to a receiver for a specific period with the expectation of it being returned. Loans are typically associated with money and come in various types, catering to different circumstances.
When borrowing money through a loan, you and the lender agree on the amount of money to be borrowed and a repayment date. A repayment plan is also established, which can either be a lump sum or a series of instalments, often paid monthly.
Interest is typically added to the loan, which is a set amount added to every instalment of the loan that you pay back. This means that you’ll have to pay back more than what you borrowed as a courtesy to the loan provider for lending you the money. Check out our interest rate guide to learn more about interest rates and what they mean.
There are two types of loans: secured and unsecured loans, each including various loan types for different purposes of the person requiring the loan.
Secured loans and how they work
Secured loans are a type of borrowing that involves using collateral to ensure that the loan is protected. A collateral is something valuable that you own, which is worth more than the loan itself, and can be used to cover the costs of the loan if you are unable to make the repayments. Typically, secured loans use your house as collateral, if you own the property. If you are unable to make the repayment, the collateral from your home will be used to cover the costs. There are a few different types of secured loans, find out how they work below:
Mortgages
A mortgage is a type of secured loan that you can take out from a bank or a building society to buy a house or property. The bank or building society lends you the money to buy the property, and you agree to pay back the amount plus interest over a set period. You will need to make monthly payments towards the loan, and if you fail to make the payments, the lender has the right to take back or sell the property. It’s important to make sure that you can afford the monthly mortgage payments before taking out a mortgage.
Home Equity Loan
A home equity loan, also known as a homeowner loan, is one where the lender will enable you to borrow money against the value of your home. For instance, if your home is valued at £300,000 and you have £50,000 outstanding on your mortgage, then the equity of your home would be £250,000. This type of loan will allow someone to raise money without selling their home. As with any type of secured loan, monthly fixed repayments would need to be made, but failure to make a repayment could put your home at risk. However, if the value of your home decreases, you could end up owing more than your home is worth, and if you decide to relocate, you may end up losing money on the sale of the home.
Unsecured Loans and how they work
An unsecured loan, also known as a personal loan or an instalment loan, requires monthly payments until the debt is fully paid off. However, if you miss or are unable to make a payment, you don’t have any collateral to help clear your debt, which means additional charges will be added to your debt. See our guide to learn more about unsecured loans.
There are various types of unsecured loans available, and each has its unique way of working. Below, you can find out more details on how they operate.
Payday Loans
A payday loan is a short-term loan designed to cover your expenses until your next payday. You can take out this type of loan if you have unexpected or urgent bills that need to be paid. As you are borrowing a small amount of money for a short period, payday loans can be approved quickly. However, they come with higher interest rates set by the lender, so it is important to only take them out if necessary. You can learn more about payday loans by checking out our payday loan guide.
Finance and hire purchase
These types of loans are commonly used to purchase expensive items or equipment. Finance options are typically available for household equipment, electronics, and even cars. The seller of the item you want to buy will use a lending supplier to pay for it, and you will then make monthly payments to cover the cost of the item until your debt is cleared, with interest added on. Hire purchases are similar types of loans, but with this, you will make monthly repayments directly to the company you are purchasing the item from. Once the debt is cleared, you will own the item.
Guarantor loans
If you have bad credit or no credit history, a guarantor loan can be a suitable option. This type of loan requires someone else to support you in making the repayments. In case you miss a payment, the lender can legally ask your guarantor to cover the cost. This can be a better option than applying for a bad credit loan, and is the only option you can use if you have no credit at all and need to take out a loan.
Credit Union Loans
This type of loan involves a cooperative where members pool their savings to provide each other with credit at a lower interest rate. The cooperative usually has a shared bond, such as living in the same area or working for the same employer. As with any unsecured loan, monthly repayments are required. You can find a credit union through sources such as the Association of British Credit Union.
How to apply for a loan?
If you have found yourself in a situation where you require a loan, and know the type of loan you need, the next step is to apply. You can search for a loan provider online or seek one in person. From there, you will fill out an application, which will include questions to help confirm your identity and understand your financial situation. Once your application has gone through, the lender will request information from your credit report which will tell them the likelihood that you can afford it and will be able to meet the loan repayments.
Remember, taking out a loan will leave a mark on your credit score. A loan will temporarily lower your credit score, and failure to make a loan repayment will push your score down even more. You should, therefore, ensure you space out loan applications to allow your credit score to improve after taking out an initial loan. There are many more ways you can improve your credit score to give you a better chance of securing a loan.
