Personal Loans: Various Types of Personal Loans
- 7th June 2018
- Posted by: Loanable
- Category: Resources
If there is one thing we as consumers and borrowers are, and that is spoiled for choice. No matter what it is you may want or need, there is plenty to choose from.
If you need to buy a car, just look at the various makes and models available, and then the different colours, accessories available, and oh yes, do you want petrol or diesel.
Look at clothing, all the many styles, colours, and brands you can choose from.
Wanting to buy a property, do you want a flat, terrace style house, duplex, or fully detached house. Maybe you want some land to develop, or a block of flats to let out. You have plenty of choice.
The same is true in banking, borrowing money, and personal finances.
There are many banks and lenders to choose from, and also many different types of loans.
If you are buying a car, you may need a car loan, or car financing, and there are various financing options available, all to cater to your specific borrowing needs.
If you buy a property and need a loan, a mortgage is the type of loan you may require to finance the property.
Many different types of loans, all with specific purposes, and for a specific set of borrowing needs.
Under the term “personal loan” there are also many different forms of loans, each with its own characteristics, and terms for that type of loan.
To define personal loans, it can be simply stated as a loan from a lender directly to a borrower. The terms and conditions are outlined in the loan agreement, and the borrow repays the loan in accord with the terms outlined in the agreement. However, as we will see, the terms for various personal loans are different, based on the type of loan the borrow has taken out.
In addition, each type of personal loan may have a specific purpose for which the loan is to be used for.
In most instances, personal loans are unsecured loans, this means that there is no collateral securing the loan.
Loans such as HP or Hire Purchase financing, or a mortgage to buy a property, are secured loans. The item being purchased and financed on HP, secures the loan. In the example of a mortgage, the property secures the mortgage loan.
With secure loans as there is collateral securing the loan, they are considered to be a lower risk loan to the lender as they have something they can physically take back or repossess.
Personal loans being unsecured, are considered a higher risk to the lender as there is no collateral, or physical item to repossess.
We will look at how this “higher risk” types of loans can be harder to qualify for, and may require a higher credit score and better credit rating.
We are also going to look at how the term of a loan, or length of the loan, affects the payments, in addition to the interest rate that may be charged by the lender.
Some lenders are very specific in the types of personal loans they will offer, they may only offer one specific type of loan, where as others, such as credit brokers, can help a borrower find any kind of personal loan.
Types of Personal Loans
As mentioned, personal loans are loans that are usually unsecured, and made between a bank or lender, directly to the borrower.
Personal loans take on many forms as we will see, and can be from just a couple hundred of pounds, to tens of thousands of pounds.
The loans can be as short as 30 days or less, to terms that are many years.
Interest rates can vary as well, due to the type of loan, how long the loan is for, and other lending risk factors, such as credit score and credit history.
So on with the various types of personal loans.
Bank Loans or Instalment Loans
These types of loans are unsecured loans made by a bank or lender to a borrower, and the loans can be used for any personal use the borrower may have. They may wish to purchase a car, and by already having the loan and cash in hand, they can negotiate like a cash buyer.
They are also called instalment loans.
The loan may be for a wedding, holiday, home improvements, even to consolidate other loans, credit cards or debts.
The terms for these loans can vary from six (6) months, to many years, with the interest rates also varying according to loan amount, the term, and also the borrower’s credit score.
As with all forms of personal loans, unsecured loans are a higher risk to the lender than secured loans. This means that for some personal loans, the borrower may be required to have a good credit rating or high credit score. We will see that not all personal loans are based on credit scores, but unsecured personal loans for larger amounts, lenders will want a borrower with a reasonably high credit score.
As to what that exact credit score needs to be, varies among lenders. It can also vary depending on the size of the loan, and for how long the loan is for.
Credit cards are a revolving form of a personal loan.
A bank or credit card issuers grants the card holder a credit limit, and as the card holder uses the card to make purchases, the remaining credit limit drops or goes down.
As the card holder makes payments to the account, their credit limit is restored, however, it can not exceed the original credit limit, unless approved by the bank or lender.
As credit cards are considered a moderately high risk to lenders, their interest rates can reflect that risk as the rates can be high.
In essence a bank or card issuer is saying, here is a £1000 credit limit, you can spend it as you wish on anything you want.
This and the fact credit cards are unsecured, add to the risk to the lender.
One aspect of credit cards is their convenience, and another is how payments are calculated.
By carrying and using a credit card, you do not need to carry large amounts of cash on you to make a purchase.
Monthly payments are a percentage, usually 2.5% to 3% of the outstanding balance each month.
This allows the user to make minimum monthly payments and stretch out the cost of the purchase(s).
This ease of payment, also adds to the interest a card holder may pay. By just paying the minimum monthly payment each month, it can take many, many years to pay the account in full. Especially if you are still using the credit card as you make payments.
Credit cards are also good for emergencies, when someone may need to make a purchase now, and pay for it later.
Overdrafts are a form of personal lending that is arranged by your bank and attached to your bank account.
Should you write a cheque (who writes cheques these days), or have a debit being taken out of your account, and you do not have sufficient funds in the account to cover the charge, the money is taken from your overdraft.
Overdrafts are good for such emergencies, however, they must be paid back upon the next time money is paid into your account.
Overdrafts carry fees with them, which are also paid when they overdraft is paid back.
Unauthorised overdrafts, or having the bank pay a charge for you when you do not have the money in the account, ca be very expensive. Some banks are trying to limit these unauthorised overdrafts, and the fees associated with them.
Overdrafts are also a form of Line of Credit.
Lines of credit are personal loans that are similar to credit cards in that they can be revolving.
A bank issues you or a company with a line of credit that is capped at £2,000.
You can use that line of credit to make purchases, up to the credit limit. And similar to credit cards, as you make payments or pay towards the credit line/limit, you have access again to that amount remaining up to the maximum limit.
Payday loans are a form of personal loans that are short-term loans, usually for 30days or less. They are also a form of personal borrowing that does not rely on credit scores, or credit rating.
Payday loans are based on the fact the borrower is working, has a bank account and can show affordability in repaying the loan.
Since payday loans are for such a short period of time, the interest rates for them seem quite high or exaggerated. Interest rates or APR’s/annual percentage rate for payday loans can be 1500%, 2000% or higher.
This is due to the fact the interest rates, while high, are expressed as an APR, which is an annual rate.
The fact that payday loans are easy to qualify for, and credit is not used in approving them, and the fact they can be approved and the money to the borrower very quickly, they have become a very popular form of personal borrowing.
Guarantor loans are another form of personal lending that also does not require the borrower to have a high credit score, or good credit history.
This form of personal loan is based on the borrower having a guarantor, and both the borrower and the guarantor can afford to repay the loan.
A guarantor is someone the borrower knows, a close friend or family member, who will guarantee the loan, which means should the borrower fail to pay the payments, the guarantor will pay the payments.
Guarantor loans are a good way for someone to rebuild their credit history, if they have had bad credit in the past.
Guarantor loans can be for varying terms, 12 months, some as long as 60 months. The interest rates ten to be higher than a personal bank loan, but lower than payday loans. The loans can be for any use just as a personal bank loan, consolidate other accounts, home improvements, a car, etc.
As you can see, there are many types of personal loans, each with their own terms, and uses.
Next let’s look at the difference between short-term personal loans, and long-term personal loans.