What is a loan?
In today's world, managing our finances effectively is an important part of achieving our goals and maintaining stability within our lives.
Whether it's purchasing a dream home, starting a business, or funding higher education, many of us will need to rely on loans at some point in our lives.
Loans can play a pivotal role in personal finance, empowering us to bridge the gap between our aspirations and our existing financial resources.
From different types of loans to complex terminologies deployed by experts, understanding the intricacies of borrowing money can seem like a daunting task to undertake, especially if you’re in need of funds urgently.
We've created this guide to demystify the process of applying for a variety of different loans.
In this article, we'll break down the fundamentals of loans, shedding light on the key components at hand, the benefits taking out a loan can bring, and any potential risks involved in this financial tool.
Whether you're a first-time borrower or someone seeking a refresher course on loan management, our aim is to endow you with the knowledge you’re after to navigate the world of personal finance confidently.
Making sense of loans
So, what exactly is a loan?
Many people in the UK use this form of financing to get them through those rainy days where personal savings don’t quite add up to the amount you need.
A loan is therefore a hugely common financial transaction, and the process of obtaining one isn’t as intimidating as it may seem at first.
Essentially, one party, normally a lender, provides a specific amount of money to another party, formally known as the ‘borrower’.
If you take out a loan, you agree to repay the cash you’ve been given, usually with additional interest. This typically takes place over a period of time, agreed between you and the lender in question.
Loans work as a means of getting access to immediate funds. Some lenders release funds within a few days and others can take up to a month. It all depends on the type of loan you go for.
They can also be used for a huge range of purposes like making large purchases, funding expenses related to education, starting that business you’ve been mapping out, or consolidating debts you already have on the back burner which you’d like to clear.
Each product has a different level of flexibility, so it can be beneficial to discuss the loan terms with your lender before you agree to anything.
What types of loan are available on the market?
Personal Loans
Personal loans are very versatile as a product.
They can be used for a number of purposes, ranging from debt consolidation to home improvements.
They are typically offered in an unsecured arrangement, meaning they don’t require collateral, and you receive a lump sum in your bank account which is repaid over a fixed term.
Mortgages
A mortgage is a loan specifically designed for purchasing a home of some description. They either come as a personal mortgage, or a buy-to-let mortgage.
These loans are generally always secured by the property which is being purchased with it.
Repayment on a mortgage is usually spread out over an extended period, sometimes ranging up to 35 years depending on your circumstances and which deals you get offered by a lender.
Because of their length of term, as well as collateral, you’ll be pleased to know that mortgages often have lower interest rates compared to other types of loan. However, in the current economic climate, beware that rates are liable to change with little notice.
Car Loans
Car loans are used by plenty of people to finance the purchase of a vehicle.
These kinds of loans can be obtained through banks, credit unions, or directly from dealerships where you’d purchase a vehicle. Sometimes, you’ll get better rates by financing with the people you’re buying the car from.
Like mortgages, car loans are usually secured by the vehicle which is being financed through the loan, and repayment terms can range from a few years to several years, depending on what you’re after, and how good your credit is.
Student Loans
Student loans are a bit different to a lot of other loans, and they’re most likely to be offered by the government if you live in the UK.
They’re specifically designed to fund education expenses. Many costs hit you once your higher education is underway, so you’re likely to need loans to cover expenses like tuition fees, books for your course, and of course, rent.
These loans are predominantly accessed through institutions like Student Finance England. However, private lenders also offer loans designed for student in some cases, if your government backed loan doesn’t quite cut it.
Student loans carry highly flexible repayment options as they’re viewed as a necessity for most people.
One main perk is that the lender will defer repayment until after graduation, and only start charging you once you earn over a certain amount of money.
Business Loans
It probably won’t surprise you to know that business loans are intended to fund various business needs.
Expanding your operations, purchasing heavy duty equipment, or managing cash flow are all aspects of running a business which a loan can help with.
Business loans can also help if your business is in its early stages too, as you can also use them to start a new business.
As a relatively flexible product, these loans can be secured or unsecured.
The terms and conditions you’re bound by can vary based on the lender you opt for, and the profile of your business. For this reason, it’s a great idea to scour the market for a few options before choosing a lender.
Credit Cards
Although they’re not strictly a loan, we’ve included credit cards due to the sheer number of people who borrow through them.
Credit cards allow you to borrow money up to a certain credit limit which is agreed between you and the lender.
If you’re a cardholder, you can make purchases or withdraw cash using your card and are then required to repay the borrowed amount within a specified time frame.
If the balance you’ve used is not paid in full each month, interest is charged on the remaining amount. However, the rate is usually quite low.
Who offers loans?
It’s a myth that you need to get a loan from the institution you already bank with.
In fact, it’s advisable to look around the marketplace instead of sticking to your existing bank, as you need to be sure you’re getting the best deal that’s at your disposal.
Loans can be obtained from a number of different sources including any high street bank, credit unions, lenders who exclusively operate online, and even individuals who offer loan services. This is called peer-to-peer lending.
What’s the deal with interest?
We’ve all heard of interest before, and we referenced it earlier.
However, it’s important to recognise what it means in the context of loans.
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It’s expressed as a percentage of the loan amount you take out, and can either be fixed, therefore remaining at the same level throughout the loan term, or variable. This means it will fluctuate based on market conditions across the country.
APR
Another aspect of understanding interest is the APR attached to loan products available on the market.
You may be thinking, ‘not another term!’ However, it’s a vital figure to consider as a borrower.
APR stands for ‘Annual Percentage Rate’. It’s a standardised metric used across the world of loans to express the actual cost of borrowing, including both the interest rate and any additional fees or charges which may be associated with a loan you take out.
The APR provides you with an understanding of the total cost of taking out a loan over a one-year period. Ultimately, this makes it easier to compare different loan options you come across, and ensures lenders are being transparent about their offers.
While the interest rate represents the percentage of the loan amount which will be charged as interest, the APR encompasses additional costs you might incur when borrowing.
This can include things like origination fees, closing costs, and other finance charges. By including these additional costs, the APR offers a more comprehensive picture of the true cost of borrowing.
Lenders are required to disclose the APR by law, enabling you to make informed decisions when comparing loan offers.
It is important to note that APR calculations may vary slightly depending on the specific regulations in each country or region, or how the lender chooses to calculate it.
However, in a lot of cases, the APR serves as a valuable tool to evaluate and compare loan options based on their total cost, enabling you to make much more informed financial decisions.
FAQ
What is interest on a loan?
Interest on a loan is the extra amount charged by the lender to cover the cost of borrowing money from them.
It covers the lender’s expenses and gives them a bit of extra incentive to lend you the cash you’re after.
It’s expressed as a percentage of the loan amount and can be fixed or variable.
Do I have to get a loan from my current bank?
No, you’re not under any obligation to get a loan from your current bank.
In fact, while it can be easy to approach your current bank for a loan due to an existing relationship, you have the freedom to explore loan options from any lender you can find.
It’s also advisable to do so to get the best deals.
This allows you to find the most suitable loan to fit your financial needs and future goals.