What are the different types of loans?
With so many different types of loans available, it’s important to understand how each works – as well as the benefits and potential pitfalls. Here’s a simple guide to help you decide which loan might suit you if you need to borrow.
With that point above in mind, it’s important to stress you should only borrow for something you need and can afford, not just because you find a good deal. Otherwise, you risk a debt spiral.
With so many different types of loans available, it’s important to understand how each works – as well as the benefits and potential pitfalls. Here’s a simple guide to help you decide which loan might suit you if you need to borrow.
With that point above in mind, it’s important to stress you should only borrow for something you need and can afford, not just because you find a good deal. Otherwise, you risk a debt spiral.
60-second summaryHere’s a top-line summary of the main types of loan (but there are more).
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Why do you want a loan?
If you’re trying to decide which type of loan works best for you, a good place to start is the reason you want to borrow money. Perhaps it’s to cover unexpected repairs to your car or to fund a new kitchen. Or maybe you want to bring together existing debts and pay them off with a single loan.
We take a look at the main types of loans available…
1. Personal loans (unsecured)
A personal loan can be used to borrow up to £25,000, though the precise amount will depend on your circumstances. You can normally borrow the money for between one and five years, but this varies by lender.
As you’d expect, you’re charged interest and this too is dependent on your circumstances. A lender will typically add the interest over the life of the loan to the amount you borrow, then divide that sum by the number of months you’re borrowing for. That amount is your monthly payment, so it’s all cleared when the term is over.
Personal loans are often called unsecured loans because you don’t need to put up a valuable asset as security.
Advantages:
- You can normally use the money for whatever you like, but some lenders may have certain restrictions.
- You can choose how much you want to borrow and the time to pay it back, subject to meeting the lender’s criteria for your choice.
- You repay a fixed amount each month, which helps when you’re budgeting.
Disadvantages:
- Higher interest rates compared to secured loans.
- You need a good credit score to get the best interest rates.
Could be used for: moderate expenses such as a wedding or car, unexpected expenses such as a broken boiler, or smaller home improvements.
2. Secured loans
A secured loan uses a valuable asset that you own, such as your home, as security for the loan. If you can’t keep up with the monthly repayments, that asset could be repossessed by the lender to recover the money you owe them, so it’s vital you understand this risk.
If you meet the lender’s criteria, you can typically borrow more than on a personal loan, sometimes up to £100,000. You may also be able to pay it off over many years or even decades.
Headline interest rates are often lower than for a personal loan. But if you’re borrowing over a long period, you may pay more in interest because you’re being charged interest for a long time.
Advantages:
- Because a secured loan is less of a risk to the lender, you might be able to borrow a larger amount – up to £100,000.
- Interest rates tend to be lower than on personal loans.
- You can take the loan out over a longer term, which makes your monthly repayments more affordable.
Disadvantages:
- You risk losing your asset (your home) if you don’t make the repayments.
- If you take the loan out over a longer period, you’ll pay more in interest overall.
Could be used for: expensive home renovations or debt consolidation.
3. Guarantor loans
A guarantor loan is commonly a type of unsecured loan, but some banks say a guarantor loan can also be a secured loan.
This type of loan is guaranteed by someone who agrees to pay back the loan if you can’t. A guarantor is usually someone who has a good credit record – often a close family member or friend.
Advantages:
- An option if you have a bad credit score or no credit history.
- If you make the minimum payments on time each month, a guarantor loan can help build your credit score.
Disadvantages:
- The guarantor is legally responsible for the loan if you can’t make the payments.
- Interest rates are usually higher than a standard personal loan.
Could be used for: someone with bad credit or no credit history who wants to improve their chances of being accepted for a loan.
You can’t compare guarantor loans with Compare the Market.
4. Debt consolidation loans
A debt consolidation loan lets you pay off multiple existing debts by combining them into one manageable loan, and can be one of the loan types mentioned above
Advantages:
- Can have a lower interest rate than your existing credit card or loan debt.
- One payment made once a month is easier to manage.
Disadvantages:
- If the debt consolidation loan has a longer term than your existing debt, you may pay interest for longer. This means your loan could end up costing you more overall.
- You might have to pay fees to set up the loan and settle your existing debts. These could outweigh any potential saving you make by consolidating your debt.
- If you opt for a secured loan and miss payments, then your asset (such as your home) is at risk.
Could be used for: people with multiple high-interest debts looking for a more manageable repayment structure.
5. Loans for bad credit
Bad credit loans are designed for people who have a poor credit score or no credit history at all. They typically have higher interest rates and more restrictions than other types of borrowing, such as a minimum loan term or a borrowing limit. Like debt consolidation loans, you can essentially class many types of loans as a loan for bad credit, as long as you meet the lender’s criteria.
Advantages:
- If you repay your loan on time each month and show you’re a responsible borrower, your credit score should start to improve, assuming you manage other commitments well.
- While acceptance isn’t guaranteed, you’re more likely to be accepted for a bad credit loan than a standard loan if you have a poor credit.
Disadvantages:
- Typically come with higher interest rates. Any missed payments could further damage your credit score and put you into more debt.
Could be used for: people with limited borrowing options due to a low credit score, but who can manage repayments responsibly.
6. Bridging loans
A bridging loan is a short-term loan used to ‘bridge the gap’ when you want to buy something but are waiting for funds from the sale of something else. You often borrow for a relatively short time, such as weeks or months.
A bridging loan is often used when you want to buy a new property but you’re waiting for the sale of an existing property to complete.
Advantages:
- Helpful in property transactions, allowing buyers to act quickly in competitive markets.
Disadvantages:
- Higher interest rates than standard long-term loans.
- May involve extra costs, such as arrangement fees, valuation fees, legal fees and exit fees.
- Designed for short periods, so borrowers must be ready to quickly pay back the loan.
Could be used for: property purchases when funds from a sale are delayed.
You can’t compare bridging loans with Compare the Market.
7. Car finance loans
Car finance covers multiple ways to borrow money to pay for a new or used car. Options include personal contract purchase (PCP), hire purchase (HP), a personal car loan or leasing.
Read more on how car finance works.
8. Payday loans (very risky)
Short-term loans for relatively small amounts – from around £50 to £1,500. Payday loans come with very high rates of interest so should be treated with extreme caution. If you’re struggling financially, it’s wise to seek debt help before applying for one.
Advantages:
Quick access to cash with minimal eligibility requirements (but many also class this as a disadvantage, given the risk of them making debt problems worse).
Disadvantages:
You could get trapped in a spiral of debt if you can’t pay back the loan. Although fees for late payment are capped by the Financial Conduct Authority (FCA) at £15 plus interest on what you borrowed, interest rates on payday loans are often as high as 1,500% APR. If you can’t make the loan repayments, you could quickly find yourself in a difficult financial situation as the interest mounts up.
Could be used for: unplanned expenses, but always explore other options first.
You can’t compare payday loans with Compare the Market.
If you’re worried about debt, Moneyhelper can direct you towards free debt advice.
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The Editorial Team - Compare the Market
Experts in personal finance, insurance and utilities
Compare the Market’s Editorial Team is made up of industry experts with decades of experience in personal finance, insurance and utilities. Each of our authors has an area of expertise, where they can share their extensive experience to help you get a better deal, by finding the right product and saving money.