A Beginner’s Guide to Borrowing

If you’re thinking of going out into the world to get your first loan, it can all be a bit bewildering and overwhelming. There are seemingly a million different lenders out there offering a million different types of loans. All have different rates of interest, and all cater to different credit scores. Some can be paid back over years, others within a few months. And if all this wasn’t confusing enough, everybody you know has an opinion on loans, interest rates and finance and what’s good and what’s not. To make life a bit easier, and to help make sense of it all, we’ve put together this first-timers guide to getting a loan. This should tell you everything you need to know to allow you to make an informed decision when it comes to the right loan for you.

So, where do I start?

You’ll likely have heard of bank loans, the most common type of loan which is often only available to those with a good credit history. Then there are payday loans which are notorious for their inflated interest rates but what about in between? These are but the tip of the iceberg of your loan options – there are many more out there.

Before we go into loans, we’ll explain some of the key things you need to know first before getting a loan: credit ratings, interest rates, unsecured & secured loans.

Your credit rating

Almost all lenders will use something called a credit rating to assess potential borrowers. This is a type of personal finance rating system which is based on an individual’s history with credit.
The idea behind credit ratings is simple: the better your rating, the better loans and better interest rates you’ll be able to get. That’s because, before someone gives you a loan, they’ll want to know you’re going to pay it back – your credit rating will help them to decide whether it’s safe to lend you money, or if lending to you is more of a risk.
Your credit rating is a score, in the form of a number, which will allow lenders to review your borrowing behaviour, in order to predict your future financial behaviour and calculate how likely you are to repay your debts. This number is calculated by looking, amongst other things, at what people have borrowed in the past, how much debt they currently have and if they have paid things back on time.

I haven’t had a loan before, does that mean I have a good credit rating?
Not quite. While not having debt can be a positive sign, it also means that there is no proof or evidence that you have a habit of paying things back on time – you’re credit invisible, in other words.
Some loan companies will be a bit wary of lending money to you, without being able to predict whether you’re likely to pay back what you owe, so having no past debt may mean you’re more likely to be declined or offered a higher rate of interest.

Interest rates

Interest refers to the amount of extra money you’ll have to pay back to the lender, on top of the money you borrowed. Charging interest is how most lenders make a profit. You’ll see Annual Percentage Rate (APR) displayed as a percentage on lender’s websites which will show how much interest they’re likely to charge. This will help you understand how expensive it would be to borrow from them. Our UK Credit Guide to Interest blog includes a full breakdown of APRs and Interest rates.

Types of Loan

Secured vs unsecured loans
An unsecured loan is given to you based on your credit rating and credit history – in other words, they are reputation-based. If you have a good credit score, and healthy financial history, lenders will generally trust you to borrow larger sums of money at lower rates of interest.
A secured loan is a loan that requires you to have something to secure your loan against – such as property or a vehicle – this is known as collateral. The idea behind this is that if you don’t keep up your loan repayments, they can seize the collateral and sell it in order to get their money back. You can read more about the differences in our Secured vs unsecured loans blog

Bank Loans
Let’s start with high street bank loans: Through a high street bank, like HSBC, Barclays, Lloyds or Halifax, you could borrow anywhere from £1,000 – £50,000 and repay over 1 to 7 years. These types of loans often offer some of the lowest interest rates around, some even starting from as little as 3% APR.
The downside to a bank loan is that these types of loans are more difficult to get – they’re generally only available to those with a good credit score, and good credit history for the bank to assess you on. For someone who is getting their first loan, the lack of financial history means that you’re less likely to be accepted. If you’re applying for a loan with your own high street bank that you have been with for years, there might be some kind of starter loan or credit for first-time borrowers that they can offer you.

Payday Loans
The other type of loan you’ll likely have heard of are payday loans – a short-term loan that can be taken out over a very brief period, often a few days to a month. They are generally quick and easy to get but their high rates of interest can make them expensive. They also come with hefty late or missed payment fees, so things could go bad very quickly if you find you can’t pay back what you’ve borrowed.

Guarantor loans
This type of loan sits in the middle of the other two types in terms of rates. Like bank loans, you can borrow larger sums of money – usually up to £15,000 and repay over 3 to 5 years. This makes them flexible and useful for several different purposes. While their rate of interest is higher than high street bank loans, this type of credit is more accessible to those with a less than perfect credit score without needing any form of collateral.

The condition with a guarantor loan is that you’ll need to find someone to act as a guarantor and support your application. In other words, someone who will agree to be responsible for the repayments if you don’t pay – the same as if an estate agent asked you to find a guarantor for a flat or house you wanted to rent.

Why do you need a loan?

Before getting a loan, it’s important to think first about why you need one.

Financial experts say that we shouldn’t take out a loan unless it’s for something important. Buying a car might fall into this category, as may borrowing to cover the cost of vital home improvements. Borrowing to cover bills or general living expenses is not ideal and many companies will refuse to lend for this reason. If you do find you’re struggling to keep up with your day to day expenses, it may be beneficial for you to seek some financial advice from a debt advice charity such as Stepchange.

Can you reasonably afford the repayments?

When you apply for credit, lenders will need to check that the loan repayments are affordable for you alongside all of your other financial commitments. It is worth giving some serious thought to both your future ability and willingness to meet your loan repayments. If it’s a larger loan you’ll be borrowing, it will prove to be a financial commitment that you’re stuck with for a long time, so be sure you can commit to the repayments for the full term of the loan before taking one out.

If you show that you’re unreliable when it comes to meeting loan repayments and financial obligations, this will be reflected by your credit score. And as anybody who has struggled with bad credit will tell you, it is easy to get a bad score but difficult to rebuild it again in the eyes of potential future lenders.

Shop around for the best interest rates

If you were on the lookout for a new laptop, television, mobile phone contract, or a pair of shoes, you’d likely shop around for the best price first – loans are no different.

Shopping around for a great deal on your loan is likely to save you money in the long run, especially if you’re borrowing a larger sum of money with a longer repayment period. And the sheer number of lenders in the loans markets, for all types of loans, means you’ll find that interest rates can vary greatly between different companies.

Using price comparison sites like MoneySuperMarket and Clearscore can help to see what’s available and allow you to compare rates easily. Some even have ‘pre-approved’ loans which will help determine how likely you are to be accepted before making an application.

Your credit score

It’s worth understanding your current credit position, before trying to make any form of application. Not only will this help you understand the likelihood you’ll be accepted for a loan, but you can also be sure there are no errors on your report which could affect your ability to be accepted for credit. You can check your credit rating for free from the three credit reference agencies in the UK:

Final thoughts

Getting a loan can be a big deal, even for those who’ve been there and done it in the past. That’s why it’s important to have all the information available to you to help make a decision. If you’re still unsure, you can seek independent legal advice from your local Citizen’s Advice Bureau, Stepchange or other independent advisors.