Personal loan advantages and disadvantages

If you need to borrow money, whether to pay for important home improvements, a new car or even to consolidate existing debt, a personal loan could be an option worth exploring.

Personal loans typically let you borrow more than you’d be able to with a credit card, and you repay this amount over a set term in fixed monthly repayments. However, they won’t be the right choice for everyone, so we take a closer look at both the advantages and disadvantages of using a personal loan to see whether they could work for you.

What is a personal loan?

A personal loan enables you to borrow a lump sum of money to be repaid over a set term – typically between 1 and 7 years. You can usually borrow any amount from £1,000 up to £15,000, although some lenders will stretch this to £25,000. The most competitive interest rates tend to be on sums of £7,500 upwards, but you’ll usually need a good credit score to secure the very best deals.

The amount you borrow is then repaid in fixed monthly repayments, making it easier for budgeting purposes. However, this also means you’ll need to ensure you can afford your repayments each month.

Personal loans are also known as unsecured loans, which means they do not need to be secured against an asset such as your home – as a secured loan would be. This means they are lower risk as there is no danger of you losing your home if you are unable to keep up with your repayments.

Pros of personal loans

There are a number of benefits to using a personal loan:

• Fixed monthly repayments. Your repayments won’t change during the term, which can make it easier if you’re on a budget.
• Choice of when to repay your loan. You will be able to select the term of your loan (usually between 1 and 7 years) when you apply – the longer the term, the lower your monthly repayments will be but the more you’ll pay in interest overall.
• Competitive interest rates. Personal loan APRs can be attractive, particularly on sums of £7,500 or more.
• Option to borrow a larger sum. You’ll typically be able to borrow more than you can with a credit card, which could be useful if you’re paying for expensive home improvements etc.
• Good for debt consolidation. A personal loan can be a great way to consolidate existing debts into one manageable repayment with one provider. If you choose a loan with a lower interest rate, you’ll save money too.
• Not tied to any assets. Personal loans are unsecured so you will not need to use an asset such as your home as collateral.

Cons of personal loans

Of course, there are downsides to be aware of too, so you’ll need to weigh these against the benefits:

• Higher interest rates for smaller sums. If you only need to borrow £2,000 to £3,000, interest rates tend to be less competitive than if you were borrowing £7,500 or more. This could encourage you to take out a larger loan than you need or can afford to repay.
• Inflexible repayments. Unlike a credit card that lets you pay off a different amount each month, repayments on a personal loan are fixed, which means you’ll need to ensure you can afford to pay this amount each month.
• You might not get the rate advertised. Loan providers have to offer the advertised annual percentage rate (APR) to at least 51% of successful applicants, but this means the remaining 49% could be offered a higher rate. Higher rates are usually offered to those with lower credit scores, while the best rates are reserved for those with good credit. If you’re unsure of your credit score, you can check yours for free with Finder.
• Early repayment charges can apply. If you repay your loan early, you might be hit with an early repayment penalty, which could be the equivalent of 1 to 2 months’ worth of interest.
• No 0% interest offers. Unlike some credit cards, personal loans do not offer any 0% deals, which means you’ll always pay interest.

Frequently asked questions

• Can a personal loan be paid off early?

  A personal loan can be paid off early, but you need to watch out for early repayment charges (ERCs). These can be around 1 to 2 months’ worth of interest so you’ll need to assess whether this is worth paying.

  That said, by law, almost everyone who took out a personal loan from February 2011 onwards can make partial or full early payments of up to £8,000 a year before penalty fees can be charged. However, if your overpayments total more than £8,000 in a year, you can be charged up to 1% of the amount being repaid early if you have more than a year left on your loan agreement, or 0.5% if there is a year or less left on your loan agreement.

• Can I use a personal loan for anything?

  A personal loan can be used for almost anything you like, such as home improvements, a holiday, a new car, school fees, a wedding or debt consolidation. But there are also some restrictions. For example, you won’t be able to use a personal loan for any form of gambling (including investing in stocks and shares), a deposit on a house, household bills or starting a business. You will usually be asked what you plan to use your personal loan for when you apply.

• Is it better to get a personal loan from your bank?

  That depends. If your credit history is limited, your chances of getting accepted for a personal loan might be higher if you stick with your existing bank as you already have a relationship with them. But if you have a good credit history, you’re more likely to find a better deal by shopping around and comparing what’s on offer elsewhere.