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Learn about how personal loans work, better alternatives to payday loans, and help when borrowing from a credit union.


Personal loans

If you want to borrow money and pay back a fixed amount every month, a personal loan is one option. Here’s what you need to think about before you borrow and how to make sure you get the best deal for you.

What is a personal loan?

Personal loans are loans that a bank or other lender makes that are not secured against any asset such as your home.

They’re also known as unsecured loans.

Personal loans – The pros

  • You might be able to borrow more than with a credit card.
  • They usually charge a lower rate of interest when compared to a credit card on larger balances.
  • Your loan repayments will also usually be a fixed amount each month, which can make it easier to budget.
  • The interest rate you pay on a personal loan is usually fixed (but not always - check that it is fixed not variable).
  • You can choose how long you’d like to take to repay the loan. Remember the length of a loan will affect the amount you’re charged in interest.
  • You can consolidate several debts into one personal loan, potentially reducing your monthly repayment costs. But be careful, as this might mean extending the length of the loan and so paying more overall.

You can make over-payments or pay off a personal loan in full or part, at any time before the end of your agreement without penalty.

However, if you repay more than £8,000 in any 12-month period the lender might charge compensation (although the amount the lender can charge is limited by law).

Personal loans – The cons

  • Personal loans have higher rates of interest than some other forms of borrowing, particularly if you want to borrow a smaller amount.
  • Because the interest rate might reduce the more you borrow, you might be tempted to take out a bigger loan than you need.
  • Most banks won’t lend less than £1,000 or for shorter than 12 months. So you might end up borrowing more than you need, or can afford.

What is a personal loan cooling-off period?

You have a 14-day cooling-off period from either the date the loan agreement is signed or when you receive a copy of the agreement, whichever is later.

If you cancel, you have up to 30 days to repay the money.

You can only be charged interest for the period you had the credit - any additional fees have to be refunded.

What to watch out for with a personal loan

  • You might not actually get the interest rate advertised.
  • You will often see the representative APR (or annual percentage rate).
  • Just over half of people who apply for and are given a loan should get this rate or better - but that could mean up to half pay more.
  • If your credit rating is less than perfect, you might be accepted for a loan but charged a much higher rate of interest.
  • Ask the lender for a quote before you apply.
  • Some personal loans have variable interest rates, meaning they can go up or down.
  • If you’re only just able to afford the initial repayments you should avoid this type of loan in case they do go up.
  • Look out for any arrangement fees, which will make a loan more expensive.
  • Make sure you include them when you work out how much the loan is going to cost you.
  • Arrangement fees will be included in the APR – which is why you should compare APRs rather than just interest rates.
  • Think carefully before accepting any payment protection insurance (PPI) your lender tries to sell you.
  • This is insurance that covers your loan repayments if you have an accident, are ill and can’t work or lose your job.
  • However, it’s been widely mis-sold in the past and many of the policies on offer weren’t adequate or didn’t pay out at all.
  • Even if you do want this cover, you’ll almost certainly get a much better deal by checking prices with several different providers.
  • If you’re already struggling to pay your bills and repay other debts, you shouldn’t take on extra debt such as a personal loan.

How to get the best personal loan deal

  • Don’t just accept the first rate you are offered by your bank or building society.
  • Shop around to see which providers are offering the cheapest APRs. Compare APRs (but remember that you might end up paying more if you have a poor credit history). A comparison website can help you do this.
  • Ask the lender for a quote before you apply. If they have to do a credit reference check, ask if they can do a ‘quotation search’ or ‘soft search credit check’ (which does not leave a mark on your credit record) rather than an application search (which does).
  • Consider peer to peer loans especially if you have a good credit rating. These loans might offer lower interest rates and are available for smaller amounts. They are featured in most comparison tables.

Check the best personal loan rates on the Which? website.

Secured personal loans

If you own your own home, you might be tempted to consider a secured loan.

However, this is a much riskier option as the money you borrow is secured against your home.

This means that if you can’t repay the loan, the lender could force you to sell your home to pay off what you owe.

Payday Loans

Payday loans are high cost short-term loans designed to tide people over until payday. Typically you have until your next payday to pay back your loan plus interest, although some payday lenders let you choose the repayment period and date. 

On the repayment date, the lender takes the amount you have borrowed plus the interest charged directly from your bank account. You will need to make sure you have sufficient money in your account to pay essential bills like mortgage or rent, heating and food, otherwise you could end up going overdrawn and having to pay bank charges.

Only take out a payday loan if you are absolutely sure you can repay it on time and don’t be tempted to roll over the loan. If you are already in financial difficulty they are unlikely to help you in the long run. If you need more than a month to repay find a cheaper alternative and if you have a poor credit rating don’t assume you can’t borrow elsewhere.

When used in the right way, short-term loans can give you choices about your spending that might not otherwise exist.

To make sure that you make a good choice, ask yourself these questions before you apply:

  1. Is it at least six months since I last took out a short-term loan?
  2. If I pay the loan back in full on my next payday, will I have enough left to pay all my bills, food and travel until the payday after?
  3. Do I really understand what getting cash now is going to cost me in the future? Exactly how much will I have to repay and when? How much extra will it cost me if I can't pay on time?

If you answered no to any of these questions you might want to think about alternatives.

Alternatives to Payday Loans

If you need to borrow money and are thinking of getting a payday loan, stop to consider your options. Although easy to set up, a payday loan can quickly turn into a problem debt for many people. It can also affect your credit rating if you don’t pay it back on time.

Borrowing to pay for everyday essentials

A payday loan is almost certainly not the answer if you need the money to:

  • pay household bills
  • pay rent or a mortgage
  • pay back people you owe money to.

If you’re struggling to pay for the essentials, speak to a debt adviser.

They can help you work out a budget, prioritise your debts, talk to everyone you owe money to and help set up a repayment plan.

There are lots of organisations that can help with free, confidential debt advice.

There’s no need to spend money paying a debt management company to help you sort out your money worries.

Money for non-essential spending

Payday loan companies might advertise payday loans for things like nights out, new clothes or other treats.

But if you do this, you’ll end up paying much more than if you waited and saved the money to pay for them.

And if you just can’t wait, there are usually far cheaper ways to borrow.

Try Community Development Finance Institutions (CDFIs) as an alternative

Community Development Finance Institutions (CDFIs) are small independent organisations that offer loans to people who have been turned down by their bank or credit card company. They tend to be local organisations offering a personalised service that then reinvest any profits they make back into the community.

Community Development Finance Institutions and all other organisations offering consumer credit have to register with the Financial Conduct Authority (FCA) and abide by their rules and standards.

You can find an alternative lender, including CDFIs, near you using the Finding Finance website. The Finding Finance is run by Responsible Finance, the membership body for responsible lenders.

Other ways of borrowing

Ask for a pay advance

If you need money before payday, it’s always worth asking your employer if they’ll give you an advance on your wages.

If you’re claiming benefits and waiting for your first payment, or if your money is late you can ask your Jobcentre Plus adviser for a short-term advance.

Normally you’ll need to pay this back out of your benefit payments.

Borrowing from family and friends

Borrowing emergency money from a family member or a friend can help you avoid the risks that go with payday loans.

But do make sure that both you and the person you’re borrowing from take the time to:

  • put your agreement in writing
  • work out a budget and a repayment plan
  • discuss what will happen if you’re late paying it back or don’t repay it at all.

Using a credit card

If you’ve got a credit card, you could consider using it for purchases - or even cash withdrawals, but only if you really have to, as they can be expensive.

Make sure you pay back as much as you can each month, to keep costs down, and don’t be tempted to spend more than you can comfortably afford to repay.

If you don’t manage to repay the balance on your card each month, it’s still likely to be far cheaper than a payday loan - but try to pay off as much as you can.

Using an authorised overdraft

If you have a current account you might be able to get an authorised overdraft from your bank.

These can be fairly expensive (although there are some interest-free overdrafts) but it will usually be cheaper than using a payday loan - as long as you stay within the overdraft limit.

Don’t be tempted to slip into an unauthorised overdraft as this can be very expensive and lead to serious money problems.

Borrowing from a credit union

A much more affordable alternative to a payday loan is a loan from a credit union.

There’s a cap on the amount of interest they can charge – 3% a month or 42.6% a year APR for England, Scotland and Wales, 1% a month or 26.8% APR for Northern Ireland.

An interest-free loan from the Social Fund

If you desperately need to borrow money and you’re claiming benefits, you might be able to apply for an interest-free Budgeting Loans and Budgeting Advances.

Help from your local welfare assistance scheme

If you’re struggling to pay for essentials like food, heating and clothes you might be able to get help from a local welfare assistance scheme.

They vary from area to area and can provide, for example, vouchers, pre-payment cards, furniture or white goods and food banks.

Some local authorities might also give loans - find your local welfare assistance team using this interactive map on the Children’s Society website.

Loan Sharks

Loan sharks are illegal lenders who often target low income and desperate families. They might seem friendly at first but borrowing from them is never a good idea – even if you feel you have no other options.

Why loan sharks are bad

Loan sharks will start out appearing friendly. And if you keep up your repayments, they might stay that way.

But the reality is, even if you do, any money you borrow will come at a very high price.

There are many risks attached to borrowing from a loan shark:

  • you pay far more in interest than you would through any legal borrowing. One woman who borrowed £500 ended up repaying £88,000
  • you might be harassed or threatened if you get behind with your repayments - there have been reports of people being intimidated or attacked
  • you might be pressured into borrowing more money to repay one loan with another, and end up in a spiral of debt that you can never repay.

How to spot a loan shark

A loan shark might:

  • offer little or no paperwork, such as a credit agreement or record of payments
  • refuse to give information, such as the interest rate or how much you owe
  • take items as security, such as passports, bank cards or driving licences
  • increase the debt or add additional charges at any time
  • refuse to allow you to settle your debt
  • get nasty - they might resort to intimidation, threats or violence.

How to check a lender is legitimate

The Financial Conduct Authority (FCA) keeps details of all authorised lenders.

If a lender isn’t listed as having a current authorisation to lend money, don’t borrow money from them and don’t let them come into your home.

Check the FCA Financial Services Register to see if a lender is authorised.

Loan sharks and the law

Although some loan sharks resort to intimidation and even violence, they are not beyond the law.

Any lender – authorised or not – who harasses you is breaking the law.

Some loan sharks will threaten you by saying you will be prosecuted and even sent to prison if you don’t pay up.

This can’t happen – an unauthorised lender such as a loan shark has no legal right to recover the debt.

In fact, they have no legal right to make you pay the loan back at all – because the loan is illegal.

Reporting a loan shark

If you have been approached by someone you think is a loan shark, you need to report them and contact the police if you are in immediate danger.

Refused a loan?

If you’ve been turned down for a credit card or loan there are steps you can take to understand why. There are also things you should avoid doing which could make it even harder to get credit in the future. Read on to find out more and to learn about alternative borrowing options to consider or avoid.

What you should be told if you have been refused credit or a loan

If you’re turned down for a loan or credit card, as a result of a search on your credit reference file, the credit card or loan company should tell you this and let you know which credit reference agency they used.

You can then approach the credit reference agency to ask for a copy of your file.

You can also ask the lender why they refused you - and what information they based this on - but they don’t have to give you a detailed explanation.

If you do spot a mistake in your credit file, write to the credit reference agency and ask for them to correct it.

Make sure you explain why it’s wrong, and include any evidence you have.

The agency has 28 days to act. The relevant detail in your credit report will be marked as ‘disputed’ while they investigate it.

Don’t keep applying

If you have been refused a loan or turned down for a credit card, think very carefully before applying for more credit.

Any credit applications you make – successful or not – will show up on your credit file.

Several applications in a short space of time might make lenders think you’re desperate for cash.

This might damage your credit rating further. Your credit rating affects whether you can get credit and how much you can borrow.

It can also affect the interest rate you might be charged.

What to do next

What to do next depends on why you’re looking for credit.

If you need to borrow to pay off other debts

  • If you’re looking to borrow in order to pay off other debts or to help you pay bills and living expenses at the end of the month then it’s worth talking to a free debt adviser as soon as you can.
  • They will be able to help you come up with a plan and avoid getting deeper into debt. Follow the link below for more information.

If you’re looking to fund a purchase and can afford the repayments:

  • If you’re looking for credit to fund a purchase, such as buying a car, and you can afford the credit or loan repayments, then check your credit rating.
  • You can do this by getting hold of your credit report – this is likely to be crucial in influencing the lender’s decision about whether to give you credit or not.
  • Contact one or more credit reference agencies to ask for a copy of your report.


Bad credit reports – Before you look to borrow elsewhere

If you’ve been turned down for a loan or card it could be a good opportunity for you to think about your current money situation.

If you already have debts you’re struggling to repay, you should talk to someone about them.

There are a number of organisations that offer free, confidential debt advice.

If you have paid off your debts, you should think about trying to save some money if you can to build up an emergency savings fund.

Alternative borrowing options if you have a poor credit rating

If you need to borrow some money and you can afford the repayments, there are other options beyond credit cards and personal loans.

Credit unions

Find out if there is a credit union near you.

Credit unions are non-profit organisations set up to help people in their local communities or who share a common bond - for example because they work for the same employer.

There’s a cap on the interest credit unions can charge on their loans of 3% a month or 42.6% a year APR (the cap in Northern Ireland is 1% a month).

There are no hidden charges or penalties if you repay the loan early.

With most credit unions, though, you have to save for a period before you’re allowed to borrow.

Budgeting loans from the Social Fund

If you desperately need to borrow money, you might be able to apply for an interest-free Budgeting Loan from the Social Fund.

Alternatively, other help might be available from your local authority.