‘Neither a borrower nor a lender be’ is an adage that’s often trotted out to school children and whilst its sentiment may be noble the fact is it just doesn’t seem practical in today’s society. The average level of debt for a UK household (excluding mortgages) stood at £6,016 in November 2013*.
*The Money charity – Debt Statistics January 2014 (http://themoneycharity.org.uk/media/Debt-Stats-Full-January-2014.pdf)
So it seems that personal debt is a way of life for most of us and at one time or another most of us will consider taking out a personal loan to help with unexpected bills or an exceptional purchase. But how do you know where to look and which products to consider? This guide will help you decide which products may be right for you and your needs.
What is an Unsecured Loan?
As the name suggests, unsecured loans are those that are offered without requiring any form of security or asset in return. The lender will make an assessment of the borrower based on factors such as income, expenditure and credit history and decide whether or not to offer a loan. This decision is important to lenders because without any security to fall back on, the lender is relying on its judgement as to whether the loan will be repaid.
As there is no security, the interest rates charged by the lenders will be higher than those for secured debt (such as a mortgage), which reflects the higher risk the lender is taking in offering the loan.
Interest Rates (in effect, the ‘price’ of borrowing the money) for unsecured loans vary hugely depending on the product and the level of risk the lender is willing to accept. High street banks may offer loans to customers with an unblemished credit history from as little as 7% APR – whereas some Payday Lenders charge an APR in excess of 5,000%.
Given such a vast range in price it’s important to understand the products available and which would be most suitable for your needs.
Different Types of Unsecured Loans
Instalment Loans offer borrowers the opportunity to borrow an amount of money and repay it (plus interest) over a set period of time. For example, a customer may borrow £1,000 and choose to repay it over a period of 12 equal, monthly instalments.
Similar basis to an instalment loan in that you agree to repay the loan (plus interest) over a set period of time in equal repayments. However what sets these loans apart is that the lender will ask for somebody you know to act as a Guarantor – in other words, to vouch for the fact that you’ll repay but if you don’t, they’ll pay on your behalf.
These loans are really aimed at borrowers whose credit history wouldn’t allow them to borrow from the high street lenders at the lowest rates. As the lender has this additional ‘security’ of somebody else to make the repayments, the interest rates are often cheaper than if you were to get a loan out on your own.
These loans are usually set up on an instalment basis but the big difference here is that the lender will effectively take a charge over your car as security for the loan. They do this by using a ‘Bill of Sale’ which gives them a legal interest over the car whilst still allowing you to keep it and drive it around. If the loan is not repaid the Bill Of Sale effectively allows them to repossess the car to repay the debt, subject to some regulatory procedures.
Although the loan is ‘secured’ against your car, the phrase ‘unsecured loans’ typically refers to any loans not secured against property (i.e. your house) so in that sense these qualify. They are also readily available and can pay out a loan within the hour.
Again, these loans are set up on an instalment basis but rather than being completed in an office (such as a Bank), or over the internet the lender’s representative comes to your home to arrange the loan and to collect the repayments.
Both the loan advances and the repayments are predominantly done in cash and the convenience of the lender collecting the money is often cited by customers as a plus.
Probably the one product that causes more controversy and discussion than any other. Short term loans that, as the name suggests, were designed to offer people credit until their next payday. The borrower selects how much they’d like to borrow (usually up to around £500 but can be more for repeat customers) and the length of time they’d like to borrow it over (usually up to 30 days). At the end of the term the borrower is expected to repay both the initial sum borrowed and the interest in one go.
Critics point to high interest rates and a quick escalation in fees and charges if the customer misses the repayment date.
Satisfied customers point to ease of use and speed of service as key attributes.
Increasing regulation, including a proposed rate cap for interest rates, may well change this market considerably over the coming months, but for now be very sure you can afford to repay the loan on the due date if you’re considering this option.
Peer to Peer
The loans are traditional instalment loans but what sets them apart is the fact that the money is lent by normal members of the public. The websites act as intermediaries and attract people with money to spare who can lend it out at a better rate than they’d get in a savings account.
As a borrower you apply for a loan, are vetted by the website and given a risk rating which will be translated into an interest rate – the higher the risk the higher the rate.
The website manages the collection of the repayments and management of the loan account, so as a borrower the experience doesn’t feel fundamentally different to borrowing from more traditional lenders.
These are created and run by groups of people with a common bond – such as living in the same community or having the same employer or profession. The members of the credit union deposit money into the union as savings which it can then lend out to other members as loans. Credit Unions will only lend to members of their union and may require you to have been a member for a specific period of time or to have built up a level of savings first.
Other Loan Options
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Guarantor Loans Representative Example: Borrow £4,000 over 36 months. Monthly repayment of £194.78. Total repayable is £7012.08. Interest payable is £3012.08. Fixed APR of 47.9%. Interest rate of 41%.
Personal Loans Representative Example: Borrow £300 over 6 months. Monthly repayment of £79.72. Total repayable is £478.32. Interest payable is £178.32. Fixed APR of 446.9%. Interest rate of 118.9%.
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