Last updated: 04/09/2020 | Estimated Reading Time: 5 minutes
Types of loan
There are several different types of loan available to customers in the UK, each fit for different purposes.
Any loan essentially involves a creditor (usually a bank or building society) lending you a sum of money that you the repay at a later date. But that’s about where the similarities end.
We’ve written this quick guide so help you work out which you need, if any at all.
All loans fit into one of the following two categories: secured and unsecured loans.
In This Guide:
- Secured loans
- Unsecured loans
- Home improvement loans
- Payday loans
- Debt consolidation loans
- Credit cards
When you take out a secured loan, you borrow a set amount of money against a certain asset that you own, which you put up as security.
For example, a mortgage is an example of a secured loan taken out against a property you own.
If you already have a mortgage, you can often use the equity (that is, the portion of the house that you actually own) as security.
You could also take out a secured loan using your car, this is known as a logbook loan.
When you take out a secured loan, your creditor technically owns the asset you put up until you have paid back the entire amount.
In the case of a mortgage for a new purchase, you will be required to put up a certain portion of the asset’s value as a deposit when you take out the loan.
So, if you’re property is worth £500,000, you might be required to pay £50,000 as a deposit. This give you a loan-to-value rate of 90% (as you are borrowing 90% of the property’s value).
The amount you’ll be able to borrow in a secured loan will depend on the creditor.
The same is the case for the interest rate you will be required to pay, which will be based on the value of the asset you put up, your ability to repay it (including assessment of your income), and the length of the term you desire.
Unsecured loans (or personal loans) are, quite simply, loans that do not require you to put up any asset of yours as security.
Instead, the amount you can borrow and the interest rate you’ll be charged (as well as your eligibility to borrow at all) will be based primarily on your credit rating.
As will secured loans, your income and general ability to afford to pay back what you borrow will be assessed.
Generally speaking, you won’t be able to borrow as much on an unsecured loan as you would with a secured loan, and the same goes for the term length - you’ll be able to borrow for longer if you secure your loan against your home or car.
Home improvement loans
One common reason people give for taking out loans is to use for general home improvements.
Home improvement loans are available as both secured and unsecured loans, with the loan amount, and the interest rates varying accordingly.
If you want a secured loan to pay for home improvements, consider securing it against the equity you own in your property. If you own the property outright, then you might want to think about simply taking out a mortgage, though this is, of course, a fairly long term commitment and so is not a decision to be taken lightly.
If you’re only looking to take on a fairly small level of improvements to your home (worth up to around £25,000), then you should consider taking out an unsecured loan instead. These have the benefit of being generally quicker to acquire, and there is no risk of you losing your home - though you may well have some assets seized if you repeatedly fail to make payments.
Payday loans are small, short term, unsecured loans, designed to top off your cash-flow between paydays.
Payday loans will charge exceptionally high APR, since they are designed to be paid off in one go within a month or less, rather than over a longer period of time.
While if used correctly, payday loans can be helpful, firms offering them have come under significant scrutiny recently for generally questionably practise and they are often advertised as being far more manageable than they are. Payday loans should only be considered as a last resort, if at all. You are likely to be better off with a credit card.
Debt consolidation loans
A form of debt management, debt consolidation loans involve combining all of your existing (unsecured) loans into one, allowing for a simpler monthly payment regime.
It is worth noting that logistical simplicity is the only real benefit of a debt consolidation loan, you won’t actually save any money in the long run.
If you choose to extend the term of your debt consolidation loan beyond that of your existing debts, then you will pay less each month, but will pay more money overall.
Less a type of loan as much as an alternative to a loan, credit cards should be considered if you need money to supplement your existing cash flow in a general sense, rather than to make a particular purchase.
As with loans, there are various different types of credit cards available, each with different purposes in mind. Head over to our credit cards guides section to have a look at what’s available and how to go about getting it.