Choosing which is the best type of loan for you when you want to borrow money can be challenging. Comparing the interest rate, repayment period, terms and conditions as well as considering whether your credit history means you are likely to be accepted can be time-consuming. In this article we simplify the process, giving you a side-by-side comparison of the main types of loans, including the advantages and disadvantages in order to help you decide which is best suited to your personal circumstances.
What are the main types of loans?
The main loan products fall into four main types:
- Secured loan (homeowner loan)
- Unsecured loan (personal loan)
- Guarantor loans
- Payday loans
In the table below we show you the typical terms for each type of loan. It provides general information on what is offered for these products, although you may be able to borrow more or change the repayment period by contacting a lender directly, particularly if you have an existing account with them.
|Type of loan||Typical loan amount||Typical repayment period|
|Secured loan (homeowner loan)||£3000-£25,000||3-25 years|
|Unsecured loan (personal loan)||£500-£25,000||1-7 years|
|Guarantor loan||£1000-£10,000||1-5 years|
|Payday loan||£100-£5000||1 week to 3 months|
What is a secured loan and is it right for me?
A secured loan, which is also often known as a homeowner loan or second-charge mortgage, allows you to borrow money that is secured against an asset, which is typically your home. These types of loan generally have a lower interest rate, giving you lower monthly repayments. However, because the repayment term is usually much longer the total amount you repay (including interest) over the life of the product can be much higher. The other important factor is that you are at risk of losing your home if you are unable to keep up with the repayments, so make sure you can afford them.
What are the advantages of a secured loan?
- The APR is typically lower than for other forms of borrowing as the lender is taking on less risk
- You can borrow a larger amount, if required
- If you take out the loan with your existing mortgage lender, it can make it easier to manage the repayments as it is all in one place
What are the disadvantages of a secured loan?
- You risk losing your home - or whatever item you secure the debt against - if you don't keep up with the repayments
- You can pay more in interest payments over the term of the loan
- It can take longer to complete the application process as it includes a valuation of your property/other item you are securing the debt against
- You may be liable for an early repayment charge if you do want to pay off the debt early.
What is an unsecured loan and is it right for me?
Unlike a secured loan, an unsecured loan - also known as a personal loan - does not require putting up anything as collateral. The application process is straightforward and you can get the money paid into your bank account quickly. However, the loan rates are generally much higher and you may not be able to borrow as much money. Moreover, the representative APR advertised is often not the figure you are actually offered as it is subject to status, meaning your monthly payments may be more than you first thought.
As you pay the loan back over a shorter period of time than with a secured loan, the total amount you have to repay in less as you don't incur as much interest, depending on the interest rate charged. However, you will need to budget carefully to make sure you can afford to make the monthly repayments as, although your home isn't at risk, you can harm your credit report if you are late making payments or incur defaults. This will make it much more difficult to access other forms of borrowing in the future.
What are the advantages of an unsecured loan?
- There is less risk than with a secured loan as there is very little risk of losing your home if you don't keep up with repayments
- There generally isn't an early repayment charge, so you can pay the loan back as quickly as you like
- It is easy to budget as the interest rate is generally fixed, meaning the payments are the same each month
What are the disadvantages of an unsecured loan?
- The monthly repayment is typically higher than for a secured loan
- You may not be able to borrow as much as with a secured loan
- You may not be eligible for an unsecured loan if you have a poor credit history
What is a guarantor loan and is it right for me?
A guarantor loan is, as the name suggests, a personal loan where another adult - usually a family member - acts as a guarantor for the debt, meaning if you don't repay it, they will. It can be a good option for those who have a poor credit history or if you haven't got any credit history as you haven't previously had any credit agreements. It means you have the opportunity to borrow money even if you have previously been unsuccessful.
What are the advantages of a guarantor loan?
- It may allow you to borrow money having been turned down for loans in the past
- You can generally enjoy a better rate than with an "impaired credit" loan
What are the disadvantages of a guarantor loan?
- It requires a degree of trust between the borrower and the guarantor that the repayments are going to be made and that the guarantor should only act as an insurance policy. There's a real risk of damage to that relationship if the borrower doesn't act responsibly and keep up their end of the deal
- The person who is going to act as guarantor needs to have a good credit rating to be accepted in the role
- It can take longer for the money to reach the end borrower as it first goes to the guarantor as part of a 14-day cooling-off period
What is a payday loan and is it right for me?
Payday - or short-term - loans offer smaller loans at extremely high rates, which means they are rarely the best option for anyone. Payday lenders are well known for charging extortionate rates of interest - anything up to 500% - and, in spite of them being subject to tighter regulation, there is still a real risk of people using them ending up with severe money problems.
What are the advantages of a payday loan?
- Although many of the major players have gone out of business, payday loans are still readily available, although it is highly disputable whether this is a good thing
- They can serve a purpose in a very small number of cases where the amount borrowed is small and it is paid back in full quickly
What are the disadvantages of a payday loan?
- Horribly expensive - you will typically end up paying a large amount of interest
- Major implications if you fail to keep up with the repayments, including seriously damaging your credit file
- Taking out a payday loan can affect whether you are accepted for mortgages or other forms of lending
If you are struggling with debt, there are links to free services that can help you in our article "Where to get free debt advice".
Which type of loan should I choose?
When you are weighing up which option to choose, it is worth asking yourself the following questions:
- How much do you need to borrow? You can generally borrow more as a secured loan and the monthly repayments will be smaller, although the term will be longer and you will ultimately pay more in interest. Most secured loans are over £10,000, although they can start from as little as £3,000. If you only need to borrow a relatively small amount, it may be worth using a credit card instead, which we discuss later in the article.
- How long do you need to pay it back? If you can afford to pay back a higher amount for a shorter amount of time, this is the best option as it will minimise the amount of interest you have to pay. If you can afford it, an unsecured loan presents less risk than a secured loan as you don't have to secure your home against the debt. However, you need to consider affordability as if you default on your higher monthly repayments it will affect your ability to borrow again in the future.
- Have you got impaired credit? If the answer is "yes", you may have to opt for a secured loan at a higher rate or, failing that, a guarantor loan if you can find someone willing to take it on with you.
You can read more about the relative merits of secured and unsecured loans in our article "Secured vs unsecured loans: which is best for me?". When you've decided which loan to go for, there is advice on the application process in our article "How to apply for a loan".
Alternatives to loans
If you are looking to borrow less than £3,000, it can pay to look for a good balance-transfer or money-transfer credit card deal. These can offer you an extended interest-free period and, as long as you are disciplined and pay back the full amount within that time, they give you more flexibility in managing your debt. For details of the best deals, check out our article "Best credit cards in the UK".
There is also the option of taking time to save up the money you need rather than taking out a loan. Using a budgeting app can help in the process (there are reviews in this article), as well as looking at our savings best buy tables and review of the best savings apps in the UK.
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