How do loans work?

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How do loans work?

There are a few different types of loans, like unsecured loans and secured loans, and you can use each one in different ways. 

A secured loan gets 'secured' against one of your assets like your home or your car. 

Lenders offer secured loans so they can give people bigger loans or lend to people with less-than-perfect credit scores. Lenders will ask you to promise something you own as a guarantee to them, in case you can't pay your loan back.

An unsecured loan is a loan (also known as a personal loan) you can take out without putting up something you own (like your home or car) as a way to get the loan.

Both unsecured loans and secured loans work in the same way:

1. You apply for a loan from a lender, telling them how much you want to borrow and over what time frame

2. If they accept your loan application they’ll offer you a loan at an interest rate specific to your loan application

3. The lender will usually deliver the money the next working day, if you accept the loan (you can also reject it!)

What can you use loans for?

Once you have the money, you can use a loan for anything. Some people use the money for home improvements, debt consolidation to pay off debts with a higher interest rate like a credit card or a big purchase like a car! 

What's my credit score?

The lender looks at your credit score to decide it they should give you a loan. It’s based on things like:

  • Your financial and credit history

  • Your ability to pay back the loan

  • Your income

  • Your personal circumstances

They're looking into whether you can handle a loan responsibility, so things like late or missed payments can lower your credit score. If you have a 'good' credit score, you’ll often get a better interest rate from the lender.

How do I know which loan is right for me?

Secured loans

A secured loan can be a good option if your credit score’s quite low. Because a secured loan gets 'secured' against something you own, lenders can offer bigger loans to people with a less than perfect credit history. 

They can do this because you have to promise something you own as a guarantee. If you have a lower credit score, this means the lender might be more likely to accept your loan application  than with personal or unsecured loans. Keep in mind though that the lender will still do a check to look at your credit history!

It's important to understand the risks involved with secured loans before you take one out. If you don't repay the loan or keep up with the repayments, the lender could take your car or house away from you! Missing monthly payments could mean losing whatever you secured the loan against.

Lenders can also charge you an early repayment fee if you want to pay off your secured loan early. Check the terms of agreement, but the lender should make this amount clear from your loan application. Some unsecured personal loan lenders (like Monzo 👋) won't charge you.

With secured loans, lenders use APRC, which stands for 'Annual Percentage Rate of Charge'. This is the interest rate and any other fees included (such as broker fees). It gives you the overall amount of money the loan will cost at any time. Find out more about secured loans and whether they could be right for you here.

Lenders of unsecured loans use APR. This is 'Annual Percentage Rate' which is how much you'll pay for a loan over a year, as a percentage.

Find out more about interest rates here.

Unsecured loans

Unsecured personal loans can be helpful if you're looking for a loan. Your house, car or other assets won't be used as collateral if you can't pay it back.

They can also be more flexible and often quicker to apply for than a secured loan.

To get an offer of an unsecured loan, you'll usually need good credit and a financial history which proves you're reliable. Unsecured loans can sometimes be more expensive because they usually have  a higher interest rate. This is because there's nothing to secure your loan against if you don't make your monthly payments.

How do loans work for a house or home improvements?

Home improvements can be a big financial cost, and is a common  reason you might decide to take out a loan.

There are a few options when it comes to looking at a loan for home improvement. One of the most popular choices is a personal loan. This is because payments are fixed, so it's a lot easier to manage your money. You can also choose  how quickly you want to repay the loan (usually one, three or five years).

These kinds of loans are flexible. You can repay the loan in a shorter time period if you can afford to, and save on interest they’d charge you over a longer period of time!

Don't forget that the lender will consider your credit score and that will affect the interest rate and the amount of money you're actually able to borrow.

It's a good idea to check your credit score before your loan application, because if the lender rejects your loan, your credit score can be impacted going forward.

If your credit score is holding your loan application back, there are other options for home improvement loans.

Secured loans are also a popular choice, but the risk here is that if you don't repay the loan, your home or the assets you've secured the loan against might be at risk. 

At Monzo, if you're if you're eligible, our representative APR is 14.8% for loans more than £10,000, up to £25,000. For loans up to £10,000 it’s 28.8%.

Read more about Monzo and loans here. 💸