Check your credit file
If you have any problems on your credit record, you risk being turned down by lenders or charged a high rate of interest. So the first thing you need to do before you apply for a loan is check the state of your file.
This will show how much credit you currently have as well as whether you’ve missed any repayments or paid late over the past six years. If these or other details such as your current address are wrong, you need to put them right before you apply.
You can check your report by contacting the three main UK credit-reference agencies, Experian, Callcredit, and Equifax: by law, they all have to offer a basic copy of your report.
How to check your credit report
Work out what you can afford before you apply for a loan
You will repay your loan in fixed monthly amounts, typically over a period of one to five years.
Draw up a budget to see what you can afford to repay every month: this can also help you to identify whether there are any areas where you can cut back.
Larger loans usually have lower rates of interest – and rates can vary from provider to provider based on how long the loan runs for. When you are comparing rates of a loan, see if you could get a better deal by borrowing slightly more or by taking the loan out for a longer or shorter period.
But bear in mind that usually, the longer you borrow for, the more interest you will end up paying – even though your monthly repayments might be lower.
Understand the different types of loans available
What is a secured loan?
A secured loan always has a specific asset as security: if you can’t repay the loan, the lender has the right to claim the asset and sell it in order to get the money it is owed.
By far the most common type of secured loan is a mortgage: people who fall behind on their mortgage repayments risk having their homes repossessed.
It is also possible to take out a further loan which is secured on your property. This is usually referred to as a second-charge mortgage, but it can only be secured against the value of any equity you have in your home – so if your home is worth £300,000 and you have an outstanding primary mortgage of £200,000, a second-charge mortgage could be secured against as much as £100,000 of equity.
Cars are another common asset used for loan security. Motor finance deals such as hire-purchase or personal contract plans are effectively secured against your vehicle, although technically speaking, you generally don’t become owner of the car under such agreements until the deal has come to an end.
What is an unsecured loan?
Personal loans and credit card borrowing are types of unsecured loan: if you miss repayments or default, lenders have no legal right to take any of your property in order to settle unsecured debts.
Of course, this does not mean that defaulting on an unsecured loan is free of consequences: you are likely to face penalty charges and your credit record will be damaged, making your prospects of borrowing again in the next few years much more remote.
Your debt may be passed on to a debt-collection agency which could make strenuous efforts to get you to repay what you owe. And you could have a County Court Judgment made against you. In extreme cases you even risk being forced into bankruptcy.
Secured loans and unsecured loans: other key differences
Taking out a secured loan tends to take longer than an unsecured loan: if you are using your property as security, for example, it will need to be independently valued and there is likely to be extra legal paperwork to deal with. A personal loan or credit card can be agreed almost instantly.
Secured loans can be a cheaper way of borrowing, however: they present less risk to lenders, and this means interest rates are often lower.
You can generally raise more money through a secured loan for the same reason.
From a borrower’s perspective, however, an unsecured loan is a much less risky proposition, as the potential consequences of being unable to make repayments are much less severe.
Get your head around 'APR'
The cost of borrowing money with a personal loan is normally given in terms of the APR – the annual percentage rate.
In many cases this is the same as, or very close to, the annual rate of interest. But there can be differences.
APRs are designed to show the overall cost of credit: this means that they should take into account not just interest charges, but also other potential expenses such as initial administration fees.
The impact of any one-off costs such as initial fees are spread over the lifetime of the loan – so in such cases, the APR will be slightly higher than the annual interest rate.
Financial regulators force lenders to show APRs on many types of credit, such as personal loans, credit cards and payday loans.
The APR is supposed to give a clearer picture of how much a particular deal is likely to cost in total, and should also make it easier to compare the price of one loan with another.
But as many personal loans do not have initial fees or any other extra charges, hidden or otherwise, APRs on loans tend to be very similar to their annual rates of interest.
What are representative APRs?
On financial adverts and marketing materials, lenders often show what is called a “representative APR”, which is sometimes also referred to as the “headline rate”.
This is because lenders charge different rates to different customers, usually based on their credit scores: if you have a poor credit history, for example if you have missed repayments in the past, you’ll most likely face a higher rate of interest and APR.
In the light of this, will you be entitled to the representative APR? If you have a clean credit record and a history of borrowing without missing repayments, there is every chance you will be accepted for a loan at the representative APR.
Be aware you may not get the best advertised rate
If you see a loan listed at the top of a best-buy table or in marketing material that appears to be particularly cheap, bear in mind that you may not qualify for such a competitive deal.
Lenders are obliged to offer their advertised rates to just 51% of customers, but anyone who is deemed higher risk – perhaps due to a bad credit file – could be charged more.
Shop around carefully
It is important therefore to compare loan deals from a number of providers in order to get the best rate. But if you do this by making one full application after another, it could damage your credit file: any future lender who sees you have made a large number of applications might think you have been rejected again and again – and this could count against you.
Instead, ensure that any rate checks you make are done through a lender’s soft search process, which won’t leave a mark on your credit file.
How to check your credit report