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Unsecured loans (or personal loans) are loans on which the borrower doesn’t have to offer any security for the debt. This means that your home or other assets are not at risk of repossession if you fail to repay the loan.
How much you can borrow on an unsecured loan will depend on your personal credit rating and income; the maximum borrowing is normally £25,000, which is repaid over a pre-agreed term - normally between six months and 10 years. When you take out an unsecured loan the lender will give you the money as a lump sum and you then make regular repayments, normally monthly and by direct debit.
Lenders charge interest on the amount borrowed. With most unsecured loans this rate is fixed at the beginning of the term, so repayments will remain the same throughout the term. However, some unsecured loans are offered on a variable rate, so the amount of interest – and therefore the repayments – may vary over the life of the loan.
The interest rate on an unsecured loan will normally be expressed as an APR or "annual percentage rate" and, by comparing the APR on different loans, you will be able to compare different products. The APR the lender will charge will depend on a number of factors: the size of the loan and the term as well as the borrower’s personal circumstances. You will often find that APRs become lower the more money you borrow.
The main pros of unsecured loans are that your home will not be at risk if you fail to make the necessary repayments. Unsecured loans are therefore suitable for people who don’t own their own property, such as tenants and students. Also, your application can normally be turned around pretty quickly, and in some cases you will have the money in your account by the next day.
However, unsecured loans have higher rates than secured loans. This is because the lender doesn’t have any collateral to guarantee repayment of the loan. This poses a higher risk for the lender, thus resulting in higher interest rates for the borrower.
Unsecured loans also carry restrictions about how much you can borrow and how long you have to pay it back. £25,000 is normally the maximum you can borrow and 10 years the longest term.
If you want to pay off the loan early, bear in mind that many unsecured loans come with early repayment penalties. For loans taken out after 31 May 2005 this penalty is limited to two months' interest, so in some circumstances it can make financial sense to switch to a lower-priced loan during the term.
Before May 2005 the interest on loans was usually 'front-loaded' and the way it worked was very similar to a repayment mortgage. In the early days of a loan, most of your monthly payments were used to pay the interest rather than the loan itself. So, if you redeemed it early, you often found that you owed nearly as much as you did when you first took it out.
Unsecured loans are governed by the Consumer Credit Act 1974, which contains strict regulations about how money is lent.
CashQuestions Guide to Secured Loans
CashQuestions Guide to Choosing a Loan
The Importance of Your Credit Record
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