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Choosing A Loan - A Brief Introduction

Take a walk down the high street, and look at the financial institutions, and you are met immediately with a confusing array of different types of loan, entrenched with facts, figures and percentages, and surrounded by small print and financial jargon. Try a different tack and search the internet, and the same well known institutions appear, with the same offers, alongside a whole lot more. Watching the television any evening and you will see more of the same via a different media.

Make no doubt about it, that loans are being offered to the consumer from every angle. The level of debt in the UK is now at an all time high, and according to Credit Action, at the end of February 2007 stood at £1,310 billion. The demand for loans has led to banks, building societies, and more recently supermarkets, and other well known institutions selling their wares in an increasingly complicated and convoluted manner. For someone new to finance, understanding what is being offered with the various different types of loans can be very difficult. With this in mind, the following article is attempt to describe in brief the main different types of loans available, and their relative uses and markets, and the advantages and pitfalls involved in taking out a loan.

Secured Loans

The first distinction between types of loans is between secured and unsecured loans. In simple terms, with a secured loan, the borrower will use an asset of large value and put this down as security against the money borrowed. Should the borrower then default on payments, the bank or lender is then legally allowed to repossess that asset, in order to sell it to get the money owed back. The most common example of an unsecured loan is a mortgage, where the house bought is used as the asset and a large deposit is normally needed. Unsecured loans are also used to purchase items of high value such as cars, for which there are specific loan packages available, which vary in terms depending on the value of the car and its expected useful life. Because unsecured loans are normally involving larger amounts, and the assets involved can vary considerably there is a huge amount of small details which need to be looked at when choosing your unsecured loan, for which reason, you will need to consult a financial advisor.

Unsecured Loans

Recent years have seen an explosion in the amount of people taking out unsecured loans. The most common types of unsecured loans are credit cards and personal loans, and authorized overdrafts. The difference between personal loans and the other two is that, credit cards and overdrafts don’t demand a fixed repayment schedule, you can pay back when it suits you, or just pay the minimum payment (normally the interest + the same again in repayment. For small amounts of money, it might be worth bypassing a personal loan and asking your bank to grant an overdraft which are often given interest free for low amounts, or just use a credit card. If you need to borrow lump sums of greater amounts, a personal loan is probably a better option.

Once you have chosen a personal loan, you are now faced with the barrage of offers that are being flung in your face. The first thing to consider is how much to borrow, and how long to borrow for. The simple answer, is that the smaller the amount, and the quicker you pay back, the less interest you pay. There are however, certain exceptions. In general, if you are looking to borrow around £5000, the interest rate will drop substantially if you borrow over that amount, sometimes as much as 5%. As an example take a look at the following banks loans page.

The second thing to look at is the interest rate, and here is the first thing to watch out for. Bank loans interest rate should be calculated as APR (annual percentage rate). This is a calculated amount designed to indicate the total you will pay back including all charges. Though this term isn’t 100% accurate it is a good indicator . Make sure though never to look at flat rate loans. This is a technique often used in car loans, but can be used in personal loans. A flat rate loan interest rate looks low, but should be roughly doubled to be equivalent to APR. For a more detailed explanation of interest rates on loans, see money saving expert.

Another thing to choose with your loan is whether it is to be a fixed rate loan or a variable rate loan. With fixed rate, the interest rate remains the same for the duration of the loan, and is normally slightly lower than variable. You are offered less flexibility in terms of repayment, as well as borrowing more. Variable rate loans are slightly more expensive in interest, but offer greater flexibility. You can pay off the loan immediately, or extend your loan depending on circumstances with less fees.

So, whatever you need a loan for, it is worth taking a bit of time looking at the available options before choosing. Don’t be blinded by the lowest possible percentage rate, and take some time reading the small print, and you could save yourself a great deal of money.