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types of loans
5 Jul 2018

Understanding Different Types of Loans So You Can Choose the Right One

The average Briton holds between £8,000 and £13,000 of debt – not including their mortgage, and their personal debt is only increasing. The average household debt grew 7% in the last five years alone.

What does that tell us about the state of our personal finances? We need help making ends meet, and most of us are doing it with loans and credit cards.

Debt doesn’t have to be a negative thing. In fact, it’s positive. A mortgage buys you a house in which to build a home. Purchasing a car opens up a world of personal and professional opportunities.

One-third of Britons don’t just have debt, they plan to take on more in the next year. If you’re one of them, it’s important to understand the different types of loans, so that you’re choosing the best and most manageable products for you.

6 Common Types of Loans

Considering taking on new or more debt? Different types of loans serve different purposes. Read through this overview before you begin comparing rates with other lenders:

Secured Loans

Banks aren’t willing to part with large sums of money without plenty of assurances the borrower will pay it back. In addition to a legally binding agreement, a bank tends to lend out larger sums when secured to other assets.

Mortgages and car loans are secured loans because the bank may take back the physical objects in the event you miss too many payments.

It’s unlikely you’ll secure a loan greater than ?10,000 without using a secured loan.

Secured loans are easier to get because they’re tied to assets, which may offset a low or non-existent credit rating.

Unsecured Loans

Unsecured loans tend to feature principal sums under ?10,000. These instruments aren’t tied to an asset and rely more heavily on your credit score.

The strength of your credit determines both how much you may borrow and the terms of the loan.

Common uses for unsecured loans include home renovations or expensive purchases like family holidays. Some use a loan to pay back their overdraft and avoid bank fees. Credit card debt is another common destination for unsecured loan money as terms for loans tend to be more favourable than credit card interest rates.

Credit Union or Building Society Loans

Credit union loans don’t differ in nature from secured and unsecured loans. The product is similar; it’s the vehicle that changes.

A credit union or building society requires its members to share something in common – often living in the same geographical area or working in the same trade.

While a bank considers loan applications from people who aren’t present customers, these loans are only available to credit union members. Why do members receive such preferable terms? Because in most cases, members are also the owners of the bank.

If you don’t qualify for membership of a credit union or building society, then these loans aren’t an option for you. If you do, however, there are some unique benefits. Credit unions often low, members-only interest rates and typically add more value to a customer relationship than a traditional bank.

Keep your eyes open when shopping around. Large banking groups now own many former British building societies. Halifax, Woolwich, and Bradford & Bingley were each snapped up by a traditional bank.

Don’t qualify for a building society or credit union in your area? Nationwide continues to offer main bank accounts regardless of your postcode.

Peer-to-Peer Loans

Peer-to-peer loans were once the fodder of NGOs sending cash to third-world countries. A recent spate of companies brought the concept home again, and the lending option is available to qualifying Brits.

The loan type brings together the borrower and lender – typically two individuals – and transfer the money at an interest rate that’s competitive for both. Typically, a fee is also assessed by the lending platform, and each group sets its own fees.

Peer-to-peer loans present a unique option for borrowing outside the traditional banking system. Peer-to-peer loans are:

  • Faster than conventional secured or unsecured loans
  • Requires fewer checks and is more convenient

Still, it’s crucial to enter one of these lending agreements with your eyes wide open. These platforms and products aren’t regulated by the government and thus don’t receive coverage from the Financial Services Compensation Scheme (FSCS).

FSCS protects those involved in a bank transaction by insuring the transaction for up to ?75,000.

More importantly, peer-to-peer lenders continue to offer better rates because the cost of gathering funding and servicing terms is lower than lending platforms.

Debt Consolidation Loans

Debt consolidation loans are a type of unsecured loan available in a secured or unsecured format. These products serve to roll up all your existing debt into a single, manageable monthly payment.

Borrowers with a high debt-to-income ratio and poor credit tend to receive secured debt consolidation loans tied up to their mortgage. These are typically known as homeowner loans.

An unsecured debt consolidation loan is available for smaller amounts of debt, like a single credit card with a high-interest rate.

Debt consolidation loans aren’t for everyone. In some cases, the total cost of the debt costs less when making payments on the debt instruments. A loan comes with added fees that cause some debt to be more expensive in the long run.

Additionally, these loans may not make sense for those who need to re-organise their debt rather than consolidate it.

Remember, an unaffordable secured debt consolidation loan also puts your home at risk. It’s important to be confident of your ability to make the payments over the term of the loan.

Payday Loans

A payday loan is a short-term, no guarantor loan designed to settle a temporary shortage of cash. These loans aren’t for adding an extension to your home or buying a new car. They’re for staying in your flat when you don’t have enough money for rent or getting your car unclamped when you’ve left it on a double-yellow.

Payday loans come with high-interest rates because you’re supposed to pay them back quickly. Although high-interest rates are offputting, they are one of the fastest ways to get cash when you really need it. Just be certain you’ll be able to pay the loan back within the term.

What Type of Loan Is Right for You?

Choosing the right debt is an important part of managing your finances. With an understanding of the different types of loans available, you’re one step closer to managing your debt.

Are you in need of a loan and don’t know where to start? Contact us today to learn more about your options for a personal loan.