What is a personal loan?

How does a personal loan work?

A personal loan is a way of borrowing money from a bank, building society or other finance provider to make a large purchase or plan a big life event. It means you don’t have to rely on your savings and can be used for almost anything you want, including:

  • buying a car
  • carrying out home improvements
  • upgrading your boiler
  • paying for a wedding
  • going on a dream holiday
  • emergency repairs
  • consolidating debts

The total amount you borrow – plus interest – must be repaid over an agreed period of time, called the loan term. If you don’t make the scheduled payments, you may be charged a fee, although support is available. Loans can be ‘unsecured’ or ‘secured’.

What is an unsecured personal loan?

Personal loans are usually unsecured. This means you don’t need to put up any valuable assets, such as your home, as collateral against the debt. But because the lender is taking on more of the risk, it restricts how much you can borrow. You can typically borrow up to £25,000 and pay it back over between one and seven years, usually in fixed monthly instalments.

Example of an unsecured personal loan

Let’s say you get a £10,000 unsecured personal loan with an APR (annual percentage rate) of 4.9% and a repayment term of five years. Your monthly payment would be £187.77 and the total interest paid over the life of the loan would be £1,266.20.

What is a secured personal loan?

A secured loan is backed by a valuable asset you own. This is typically your home, which is why secured loans are also sometimes called homeowner loans.

Interest rates on secured loans are usually lower than unsecured personal loans as there is less risk to the lender. You can also potentially borrow a larger sum of money and pay it back over a longer timeframe of up to 30 years. However, if you don’t keep up with your repayments, your home could be repossessed.

What do you need for a personal loan?

Personal loan requirements vary between lenders, but some of the things they’ll take into consideration when you apply for a loan include your:

  • Credit score – this is a snapshot of your financial history. The higher this is, the more likely you are to get approved and benefit from the lower interest rates available.
  • Income – lenders need to be confident you can afford to pay back the loan, so will look at your debt-to-income ratio. This measures how much of your monthly income currently goes on paying off debt. A low ratio shows that you should be able to cover your loan repayments comfortably.
  • Credit report – a credit score is the headline figure lenders use to check eligibility, but they will also do a deeper dive into your credit report to see how reliable you’ve been with money in the past. Things like late payments and bankruptcy may act as a red flag and make it harder to get approved for a loan.

Thinking of taking out a personal loan? Before you apply, use our personal loans quote tool to get an idea of how much your repayments could be based on the amount you’d like to borrow.