Everything you need to know before getting a loan


May 2024
Everything you need to know before getting a loan

Everything you need to know before getting a loan

As the cost-of-living crisis continues to bite, a recent analysis by the Money & Pensions Service suggests that one in five people are now borrowing money to pay for food and other essential bills, with half doing so for the very first time.

In fact, according to data from the Bank Of England, the annual growth rate for consumer credit in the UK increased to 7.7% in February 2023 – the highest rate since November 2018.

Even though it can be relatively quick and easy to take out a loan, it’s not something that should be rushed or taken lightly. Taking the time to choose the right deal will make your money go further and leave you financially better off in the long run.

To help you get started, we’ve unpacked all the financial jargon and compiled everything you need to know to get the best loan for you in 2023:

What can I take out a loan for?

Technically, you can take out a loan for anything. Lenders are likely to ask what you’ll be using the money for, but in most cases, this won't affect the success of your application. Still, it’s essential to use a loan for the right reasons, such as:

  • Paying emergency bills
  • Buying or fixing a car
  • Helping to fund your maternity/paternity leave
  • Consolidating debt
  • Furthering your education
  • Starting a business

If you are struggling financially, it would not be in your best interest to take out a loan for non-essential items such as a holiday or other luxuries that you otherwise couldn’t afford. You’ll end up paying interest for things you want, but don't need, and unnecessarily stretching your monthly outgoings.

Ask yourself, is this essential? Or, will this better my future? If the answer is no to both questions, it’s best to skip it or save up, rather than borrow money.

What type of loans are there?

A loan is an amount of money that you pay back in instalments within a certain timeframe. Most loans come with interest, which is the price you pay for borrowing money from a lender. There are numerous types of loans available in the UK, including:

  • Personal loans - Personal loans allow you to borrow a fixed amount of money. You’ll repay the money in fixed monthly instalments over an agreed period of time (known as the term of the loan), which is typically between three and 10 years. 
  • Payday loans - Payday loans are short-term loans where you borrow a relatively small amount of money (typically £50–£1000) and pay it back within one to three months. They come with an extremely high interest rate, making them an expensive way to borrow. Plus, if you don’t make your repayments in time, they can cause significant financial distress down the line. It’s best to avoid these entirely.
  • Joint loans - Joint loans are when you borrow money with a trusted friend or partner, meaning you’re both responsible for paying back the money. You might be able to borrow more than you’d be able to on your own. But it’s a big step – if the other person is unable to repay their side of the debt, you’ll be liable for the full amount.
  • Secured loans - Secured loans require an asset to secure the loan against – usually your property or a car. This means that, if you were unable to make the payments, your asset could be repossessed. Secured loans are usually used for larger amounts of money.
  • Unsecured loans - Unsecured loans don’t require an asset to secure the loan. You simply borrow money and agree to make regular repayments until the loan is paid off. However, because the loan is unsecured, interest rates tend to be higher.
  • Guarantor loans - Guarantor loans mean that you’ll require a guarantor (usually a family member or friend) who will agree to keep up with your repayments if you can’t. They’re often the best option for those who have a poor credit history.

How can I find the best deals?

There are loads of different loan providers out there, so it’s essential to shop around before deciding on a loan. Don’t just automatically go with your current bank, either – you might be able to find a better deal elsewhere.

The best place to start is a free comparison website like ours, where you can compare current deals from top banks and lenders without affecting your credit score. You’ll then need to spend time comparing interest rates, fees and the terms of each agreement before deciding which suits your situation best.

Before you hit search, take a look at your monthly outgoings and figure out how much spare income you have at the end of each month. This will help you to make sure that you can afford the loan repayments and decide what loan term is right for you. Make sure to leave some wiggle room for unexpected costs or changes in your circumstances.

When comparing loan deals, bear in mind these key factors:

  • Monthly repayments - Firstly, are the monthly repayments manageable for you? You need to make sure you can realistically afford to make them for the duration of the loan term. If not, you could face financial stress down the line. If you do find yourself struggling to meet your repayments, it’s worth contacting your provider to see if you can renegotiate the terms of your loan and reduce your monthly repayments.
  • Annual Percentage Rate (APR) - The APR is the overall cost you pay per year to borrow the money, including interest and fees, expressed as a percentage. Essentially, the lower the percentage, the less you’ll pay.
  • Fixed vs variable interest rates - The interest rate is what you’ll pay to the lender in order to borrow the money, expressed as a percentage. Again, the lower the rate, the better. The interest is included in your monthly repayment amount. Fixed interest rates mean your monthly repayments will remain the same throughout the term of your loan. Variable interest rates, however, mean your monthly repayments could fluctuate if interest rates rise or fall across the market. If you can, it’s best to go for a fixed-rate loan in order to avoid any nasty surprises down the line.
  • Fees & charges - Don’t forget to read the small print when taking out any loan. Will you incur additional fees if you repay the loan early or pay one of your repayments late? Have a think if any of these fees could potentially affect you and compare the loan terms with those scenarios in mind.

Are there any alternatives to loans?

Loans aren’t the only way to borrow money. If you’re only looking to borrow a small amount (think £100–£5000) and can pay it back promptly, you might be better off using a credit card.

A credit card allows you to borrow up to a set limit, as agreed by your provider. This limit will depend on your credit score. You’ll make purchases on your credit card and then pay off the balance. Most cards won’t charge you fees or interest on purchases if you pay the money back, or the minimum requested, each month. Using a credit card is normally much cheaper than taking out a payday loan.

If you don’t need to borrow a huge amount of money, it’s also worth looking into an arranged overdraft with your bank. They can be fairly expensive in terms of interest but, again, are almost certainly cheaper than a payday loan. Interest-free overdrafts are also available up to a set amount, which means you won’t incur a charge unless you go over the limit.

What’s the application process?

Before you apply for a loan, it’s worth asking for a ‘soft quote’ from the bank or lender. This means you’ll receive an indication of what rate you might have to pay, and if you meet the lender’s eligibility criteria, without impacting your credit score.

Once you’re happy with your soft quote, you can apply for the loan online, by phone, in person and even by post. You’ll typically need to complete an application form, which will require your:

  • Personal details
  • Bank details
  • Current address and previous addresses from the past 3 years 
  • Current salary/income
  • Employment details

The bank or lender will then run a credit check and ensure you meet their eligibility criteria. This includes looking at your age (you need to be at least 18), credit score and credit file, as well as your current employment and income. 

Next, the lender will make their decision and, if you meet their criteria, make you an offer. Don’t rush into accepting the offer. It’s worth taking a few hours – or even a few days – to read the small print and consider whether it’s the right fit for you.

Will my credit rating affect my application?

Unfortunately, your credit score has a significant impact on your eligibility for loans, as well as the interest rates you’ll incur.

If your credit score is rated ‘very poor’ or ‘poor’, your chances of getting a personal loan are low. If you do manage to find a lender, you’re likely to incur an extremely high APR. Ultimately, the higher you keep your credit score, the larger your access to loan options will be.

Before applying for a loan, check out your credit score using a free service such as Experian or ClearScore. If yours is low, it’s worth delaying your loan and taking steps to improve your credit score, such as:

  • Checking your credit report for errors & mistakes
  • Closing joint accounts with anyone who has a poor credit score
  • Paying all your bills on time
  • Spending within your limits
  • Avoiding making multiple applications for loans or finance