Loans

Definition of Loan:

The best definition we can find on the internet is from Wiktionary:

"A sum of money or other valuables or consideration which an individual, group or other legal entity borrows from another individual, group or legal entity (the latter often being a financial institution) with the condition that it be returned or repaid at a later date (sometimes with interest)."

Synonyms for Loan:

The following words have the same (or very similar) meaning as "loan":

Borrowing, finance, credit, advance, mortgage

Why Get a Loan?

Loans to buy stuff you can’t afford

In today’s consumerist society we are subjected to advertising that makes us want to buy lots and lots of stuff. If we can’t afford the things we want so much we can then decide whether we are prepared to pay more than the asking prices so that we can take out a loan and have it now. Many people can find themselves in a financial mess because their desire for stuff has led them to take out loans they cannot manage to repay.

Prudent people will:

  1. Never make a rush decision to buy the stuff they want
  2. Consider waiting until they can afford the stuff they want.
  3. Use a loan for stuff they want only if they can afford to repay the loan.

Loans for things you need

Sometimes it is prudent to use a loan to buy the stuff you need. For example:

  • It may be cheaper to repay a loan for a washing machine than to use the laundrette.
  • It may be cheaper to repay a loan for a car than hire a car or use a taxi. Don’t forget to include all the associated costs of car ownership (petrol, tax, maintenance, repairs, breakdown cover, MOT etc etc)

Borrowing to solve a financial problem

Although it is easy to get into a financial pickle through bad financial planning, we can also find ourselves with debt problems through no fault of our own. Whatever the reason, the best thing to do is get some independant help on finding a way out. There are several organisations who can help you who are not motivated by selling their own financial products to you. These include the Citizens Advice Bureau, Christians Against Poverty and the Insolvency Helpline.

Cheaper Loans to improve your finances

Ever heard the expression "robbing Peter to pay Paul"? That’s when you create a new problem to solve an old problem.

What if you already have a loan but it isn’t right for your current circumstances. You may wish to change it for a cheaper loan or a loan with a longer or shorter repayment period. It is very important to research the options carefully and ensure that you fully understand all the implications of settling a loan with a new one. Here are a few things to check:

  1. Make sure you get the full settlement figure on your current loan as this may be more than the balance you owe.
  2. Check the total interest payable. Spreading a loan over a longer period may reduce your monthly repayments but cost you a lot more money in the long run.
  3. Check the full terms and conditions including fees and charges for missed payments etc

What Loan options are there?

The basic types of finance include credit cards, personal loans, overdrafts, flexible loans, mortgage loans. The pros and cons of each are as follows:

Credit Cards

Pro’s -
  • You can keep using it to buy things up to your credit limit.
  • You can get automatic insurance on product purchases.
  • You can pay off as much as you like above a minimum payment threshold
  • If you remember to pay off the balance on time you can borrow interest free.
  • Some cards have rewards such as Cashback
Con’s -
  • If you get into the habit of paying off the minimum amount the time to repay the loan will be very long.
  • Having a credit card opens up the temptation to buy things on credit more often

Personal Loans

Pro’s -
  • Offers a steady repayment you can budget for.
  • Repayments usually taken by direct debit from your account on a planned day of the month.
Con’s -
  • Not very flexible to pay off early or reduce a payment if you need to.
  • Often cheaper than other types of finance.

Flexible Loans

These are like Personal Loans above but offer the flexibility to repay early. Usually suited to a term of 12 months or less.

Overdrafts

Pro’s -
  • Avoids bank charges for going overdrawn .
  • Avoids unpaid direct debits and standing orders.
Con’s -
  • Usually an annual charge to pay.
  • You can end up going overdrawn every month because credit is so easily available.

Mortgage Loans

By this we mean borrowing from your mortgage company if you have a flexible mortgage product, not a loan secured on your house.

Pro’s -
  • Lower interest rates
Con’s -
  • Longer repayment periods if you do not increase your repayments enough to get your mortgage repayment back on track.

Secured Loans

Secured loans are simply borrowings secured against your house or commonly a product you are buying with the loan such as a car. Secured loans need extra caution as missing payments could result in you losing whatever you have offered as security to the lender. If you are not sure which is right for you, read our comparison of secured loans versus unsecured loans.

The Interest Rate, Loan Amount, Repayments , Term, Fees and Charges

Choosing a loan is much more than finding a low interest rate. You should also consider the various loan parameters below. We recommend the use of a loan calculator to experiment with different amortization parameters and observe the effect on the cost of the loan.

Interest Rate

The interest rate is usually the one element of a loan we use to compare offers but this is not always the most important consideration. The cost of a loan will be much less if we first focus on the other loan parameters.

Loan Amount or Capital

The amount you borrow is normally set by what it is you want to buy but there may be other options to consider including cheaper products and increasing your deposit on the purchase.

Monthly Repayment Amount

As previously said, reducing the monthly repayment amount will only increase the loan term and cost you more. For a cheaper loan you should try to increase the payment amount to as much as you can afford. If you have an emergency fund (and that is a very prudent thing to do) you should not eat into this as if an emergency arises you will run the risk of not being able to make a payment and probably suffer a financial penalty.

Loan Term

The shorter the term, the cheaper the loan will be. This is often the biggest factor that influences the total cost of the loan.

Fees and charges

Beware loans with high penalties for missed repayments as all your work of finding a cheap loan can be undone by one missed payment.

How much money can I borrow?

The amount you borrow should effect how you borrow as follows:

Small cash loans

Loans of £100, £300, £500 are too small for many loan providers. You should consider whether an overdraft or credit card might better suite you for this purpose.

Common Loan Amounts

Loans of 1000, 2000, 3000 and 5000 are typical sizes and are well suited to the unsecured personal loan.

Larger Loans

Loans of 10000, 15000, 20000 or more are bigger business for loan companies and therefore some negotiating on the APR could reduce the cost of the loan. You may be required to offer collateral on a loan of this size. If the loan is for an expensive product such as a car then the product is usually the collateral. If the loan is for debt consolidation purposes you may be asked to secure the loan on your property. If you do this you run the risk of losing your home.

Consider lending from your flexible mortgage if you have one, bearing in mind that longer repayment periods means the total interest paid will be higher.

Problems repaying Loans?

Before taking out a loan both the lender and yourself as a borrower need to be certain that you can repay what you borrow. However, problems can arise for any number of reasons. If you are having problems, read our guides on:
IVAs
Trust Deeds for Scotland
debt Management Plans

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Updated on 29th February, 2012

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