- Benefits and drawbacks of unsecured personal loans, borrowing limits, repayment terms.
- Reducing the costs of a personal loan
- Learn about Payment Protection Insurance and the cooling off period
The Benefits of Personal Loans
Personal loans from well known high street banks and other financial institutions class as unsecured loans. i.e. there is no need to put up any collateral or asset such as a house as a guarantee that you make a full repayment.
This type of personal loan is often the first choice for many applicants. The lender cannot make a claim on the house for late repayments or full default. There is no immediate danger of losing anything. Let’s explore the other benefits of personal loans
What are the Benefits of Personal Loans?
There are borrowing limits on personal loans. The borrowing limits for personal loans are often higher than the limits imposed on credit cards. Higher limits allow for more flexibility so the applicant can borrow the amount they need. For example, if you wish to buy a car using a credit card, you would probably only get a cheap second-hand model. Whereas, if you use a personal loan, you can afford to buy a modern model which is more reliable and will last longer.
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Also, the repayments for a personal loan will be a fixed amount each month which makes it easier to budget for regular outgoings.
Most lenders set the interest on personal loans at a fixed rate. There are some products which offer variable rates of interest. Applicants should be aware that any variable rate loan will make budgeting for the monthly payment more difficult. Rates fluctuate along with the bank base rate. This makes the monthly amount needed for repayments less predictable.
The average consumer credit borrowing stood at £38,821 per UK adult in December 2016 – source The Money Charity
Borrowing in the UK is still on the increase even though the economic times are hard.
Terms For Repayment On Personal Loans
How Long Is The Term Of A Personal Loan? Most lenders will offer a choice of repayment terms for a personal loan. Terms will vary but are often between one and five years with the most popular term being 36 months. Some personal loans will go for as long as seven years. You can choose the repayment period to suit your own circumstances. But, you should be aware that the longer the term, the more interest you will pay.
Using A Personal Loan For Debt Consolidation
In a situation where you owe money on several credit cards or store cards, taking out a personal loan to consolidate the debts into one monthly payment may make life easier. However, it is important to understand that paying off debts over a longer period might mean paying more interest.
As a rule, personal loans carry a lower rate of interest than credit cards or store cards. Remember to check carefully. There is also some 0% interest rate cards on the market that might be a better option.That is one of the big benefits of personal loans.
Repaying A Personal Loan – Can I make Overpayments?
Most lenders will allow a customer to make over payments on a personal loan or to pay a loan off in full before the end of the contract. Check the agreement carefully before taking out a loan. Lenders might impose restrictions on the amount that can be repaid in a twelve month period. They also might charge a fee to compensate for the loss of interest.
The amount of compensation lenders charge is limited by law. But, it is always better to check the small print. You need to fully understand the implications of any loan agreement before signing an agreement.
In August 2014 an article emerged in the Guardian that highlighted yet another banking scandal due to errors in paperwork for personal loans. These errors meant that the agreements were not legally enforceable and organisations including Barclays and The Co-operative Bank were forced to set aside funds to pay for claims from personal loan customers.
Reducing The Cost Of Personal Loans
Potentially, you can repay a loan using any savings that you may have. It is almost always a better option to use savings to pay off outstanding debts. This is because interest rates for savings are pretty low compared to the personal loan interest rates charged for borrowing money.
In fact, the rule of thumb is that you should pay off any debts before you consider starting a savings plan. Always remembering to keep some emergency money for unexpected bills.
Choose to pay off credit cards and store card debts first or any unauthorised overdrafts. These will attract the most charges in interest and fees. The list of debts should also include any payday loans, catalogue accounts and door to door lenders. All of these debts will cost you far more than you could gain in interest on savings.
Switching the personal loan debt to another lender is also an option. With the huge amount of competition amongst financial institutions and banks, there could be a better deal out there.
The deals will save you money on interest and allow you to pay off the loan much earlier.
A loan of £5,000 over three years at 15% will attract interest of £1,239.76. A rate of 10% means you will be paying £808.09, a saving of £431.67. Of course, it is important to check whether there are any charges for setting up the new loan or any fees for switching.
Reducing the term of a personal loan is another option that can save on costs. If you can afford to reduce the term of a £5,000 loan from 5 years to 3 years, you can save as much as £442 and the monthly repayment would only be £56 more. So, if the lenders awarded you to a pay increase, it’s a good option to clear your debts earlier and will end up costing you less.
Using personal loans to consolidate debt is an option that can make life easier as monthly repayments will be reduced. However, in these difficult economic times, lenders are becoming more reluctant to allow an unsecured consolidation debt loan.
They will often ask that your home is used as collateral for the loan.
It’s very tempting to clear off debt using a secured loan. Interest rates are lower, making them more affordable. However, there is always the risk of losing your home if you do not keep up the repayments.
Even though deals on 0% credit cards are harder to find these days, there are still some lenders who offer this option. However, taking up one of these deals is risky unless you have superb discipline and can be entirely sure that you will make the full repayments and not rack up more debt.
Balance transfers to new cards come with a setup fee. This may not be cost effective as it can be a high percentage of the balance. Using an offer like this is fine as long as you repay the full amount of debt before the 0% interest rate runs out.
With any unsecured personal loan taken out after February 2011, anyone is entitled to make overpayments of up to £8,000 in any one year. You can do this without attracting any penalties.
If you want to overpay by more than this amount, there is a limit to how much lenders can charge. This amounts to 1% of the extra amount, or if you are repaying the loan in full, it is 0.5%.
To make an overpayment, you should first contact the lender for agreement, and you must give 28 days notice. Making a payment without notice entitled the lender to add a further 28 days interest to the loan.
Check the agreement if you obtained a personal loan before February 2011 to check you can make over payments without penalties.
In the not too distant past, many lenders added PPI to the terms of the loan without the borrower being aware of this extra. This is considered as mis-sold PPI. If you are unaware that you opted for this insurance, you may be able to claim a refund of payments. If you are interested specifically in the PPI feature sold with personal loans, Personal Loans Now explores it in more detail in another article.
The Drawbacks Of Taking Out A Personal Loan
So far we have discussed the benefits of personal loans, now we turn to the drawbacks of personal loans.
High Rates Of Interest On Personal Loans
Lenders offering personal loans may charge a higher rate of interest than some other forms of borrowing. This is especially when the amount you want to borrow is small. In fact, lenders will offer a lower rate of interest for higher sums borrowed. This could tempt you to take on a higher amount of debt than you actually need.
So, for smaller sums, it is better to look at alternatives such as a loan from your family or a 0% rate credit card. There is a lot of information on the Internet on comparing rates of interests to find the best way to fund your borrowing.
Repaying A Personal Loan Early
If you took out a personal loan before February 2011, there might be penalties charged for repaying the loan in full or for making overpayments to clear the loan at an earlier date. Check the agreement very carefully so that you do not get charged with unnecessary fees.
Interest Rates Can Differ For Each Personal Loan Applicant
Lenders are always trying to achieve better sales figures for loans. To increase sales, they will often advertise a headline low-interest rate.
Be aware that this rate may not apply to you. The FCA regulations for personal loans state that lenders only have to offer the low headline rate to 51% of applicants.
If you have a low credit rating, then be prepared to be offered a higher rate than the advertised representative APR or be ready to be turned down.
Personal Loans – What Is A Variable Interest Rate?
While most personal loans have a fixed rate of interest, there are some products on offer that have a variable interest rate. This means that the rate can go up or down according to Bank Of England base rate changes. It is best to avoid these loans especially if you have budgeted for the monthly repayment figure that you can afford.
Arrangement Fees And Other Charges On Personal Loans
Some personal loans, usually those set up through a broker, are agreed with an arrangement fee. This is an extra sum that you must pay either as a one off cost or it is added to your monthly repayment figure. The APR must always include the cost of the arrangement fee, and this is why using the APR is such a useful comparative tool.
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Taking Out Payment Protection Insurance On A Personal Loan
This specific type of insurance often offered along with a loan has now been widely discredited due to mis-selling in the past. However, if you do want to take out insurance cover on a personal loan (and this could be a good idea especially if you are worried about sickness), look around as there may well be a better deal with a company other than the one that is offering the loan.
One Final Important Point About Taking Out A Personal Loan
The regulations for personal loans ensure that you have a 14 day cooling off period. It starts from the date that the contract is signed or when you receive your copy of the agreement. Cancelling the agreement means that you must repay the loan and any interest charged within 30 days.
The cooling off period is an excellent opportunity for applicants to review the benefits of personal loans and the drawbacks of taking one out if you didnt have the time before.
Summary: Benefits of Personal Loans and the Drawbacks
Personal Loans Now discussed the benefits of personal loans and the drawbacks to taking one out. We looked at the benefits of personal loans which are unsecured and the drawbacks of secured personal loans. Furthermore, flexible borrowing limits and fixed rate loans make it easier to budget for the monthly repayments. We provided some tips that can help to reduce the cost of a personal loan.
Moreover, we discussed the drawbacks of higher rates of interest for lower borrowing, higher rates for people with bad credit rating, arrangement fees for early repayment and extra costs for PPI. Many of these benefits of personal loans and drawbacks are looked at in greater detail in other articles in this series.