What is a personal loan?

A personal loan, otherwise known as an unsecured loan, is a loan from a bank or building society that is not secured against any assets, e.g. your home. It is typically a fixed amount of money borrowed over a fixed period of time at a fixed interest rate (although variable interest rate loan products are also available).

How do personal loans work?

A set amount of money will be available for you to borrow when you take out your personal loan. Your loan provider will also set the term over which you need to repay your loan and the interest rate that will be charged on the amount you have borrowed. Then you will make fixed monthly repayments to pay down the balance you owe on your loan.

For example, if you were to take out a £7,500 loan over a three-year term at an interest rate of 2.8%, your payments would be £217.33 per month and you would pay £323.88 in interest over the term, meaning your total repayment would be £7,823.88.

Personal loan rates

One of the first things to look at when comparing personal loans is the headline interest rate, which shows how competitive the lender is.

The interest rate determines how much extra money you would repay on top of the value of the loan. It also lets you calculate your monthly repayments and therefore whether you would be able to afford the load.

Interest rates on personal loans typically vary depending on the amount you borrow. If you borrow a smaller amount, say £1,000 to £2,000, then interest rates are usually between 9% and 10%. However, if you borrow between £7,500 and £15,000, the interest rate usually drops to around 3%. Once you start looking to borrow over £25,000, rates start to climb.

Personal loan rates have been steadily declining in recent years, after an initial spike following the financial crisis. The Bank of England base rate has been at a record low (at the time of writing, it is 0.75%), which means the cost of borrowing has also been relatively low. However, the base rate could go far higher (the Monetary Policy Committee review it every six weeks), and any increases could be passed down by banks in their APRs. It’s best to make sure you understand the amount you will be required to repay and whether you can afford to.

Pros and cons of a personal loan

So, you are thinking of taking out a personal loan… What are the benefits or pitfalls of this type of borrowing?


  • You can borrow more than on a credit card.
  • Interest rates are typically fixed, so you know how much your monthly repayments will be, making it easier to budget.
  • You decide the length of the term of the loan.
  • Personal loans are widely available from a range of providers, so you have a competitive selection from which to choose.
  • Personal loans are unsecured, so you don’t need collateral, such as a home, in order to take one out.


  • Interest rates tend to be higher than secured borrowing in order to offset the risk.
  • Personal loans require a good credit history, as there is no collateral.
  • Loans may carry early repayment charges – you would need to compensate your loan provider if you paid off the full amount before the end of your term. Check the details of the loan to see how much the charges would be.
  • Lenders typically have a minimum amount they will lend, so personal loans are not suitable if you only want to borrow a small sum.
  • Interest rates are lower the more money you borrow, which could tempt you into taking on more debt than you need to.
  • Monthly payments are fixed, so if your personal circumstances change there won’t be any scope to change how much you repay each month.

Why your credit score matters

As no collateral is required, you typically need to have a good credit score in order to be eligible to take out a personal loan. Due to you having nothing secured against the value you are borrowing, e.g. your property or your car, a loan provider needs to know that you are a safe bet for repayment. The provider will not lend you money if it thinks you are not in a position to pay it back and meet the interest charges.

During a loan application, you will typically be asked to provide information relating to your income and employment, as well as details of your monthly outgoings, in order to assess whether you meet the affordability criteria. Providers will also check your credit report, which is a personal history of all the credit you have taken out in the past six years. This data is held by three credit reference agencies in the UK: Equifax, Experian and TransUnion (formerly Callcredit). Lenders use your credit report to check their own records and then decide whether to lend you money. There is no universal credit score, and it is the providers that make the decision to lend, not the agencies. While one lender may reject your application, another one may be more positive.

Will having a personal loan affect my credit score?

Taking on any level of debt is likely to have some sort of impact on your credit score. Credit rating agencies do look at how many active credit accounts you have when compiling your credit report. So yes, a personal loan would be taken into account as a level of debt to be repaid. However, if you are a responsible borrower and make your monthly payments and pay your loan off in the set time period, then this could help your credit score as it shows a lender that you are reliable.

Also be aware that if you are rejected for a personal loan, this could impact your credit score. Make sure you read the eligibility criteria for a loan before you apply, and where possible use a provider’s eligibility checker (which will conduct a ‘soft search’) to see whether you would be likely to be approved for the product.

Loans for people with poor credit histories

If you have a poor credit score but are still interested in taking out a personal loan, then a specialised bad credit loan could be a potential option.

There are three types of bad credit loans:

  1. Unsecured loan – although the options for these will be very limited if you have a poor credit history
  2. Guarantor loan – where someone acts as a guarantor and agrees to repay the loan on your behalf if you default
  3. Peer-to-peer loan – where you borrow from people rather than from a financial provider

Bad credit loans typically have higher interest rates and lower amounts, so make sure you shop around to get the best deal.

How much can I borrow?

Loan providers typically offer between £1,000 and £25,000, with interest rates varying based on the amount you take out. How much you can borrow will depend on whether your application is approved.

Be wary of taking on more debt than you need to: it is not in your best interests to borrow up to your absolute limit if you can’t afford to pay it back. Some providers and financial comparison sites offer free loan calculators that let you see what your monthly repayments would be based on the amount you would borrow and the length of the loan’s term. This will help you assess whether you can afford to repay a particular loan.

How to compare personal loans

Borrowers are almost spoilt for choice when it comes to picking a personal loan. Here are the key things to consider when comparing products:

  • Representative APR – This is the main difference between personal loan products. The APR determines how much you pay in interest over the term of your loan – the lower the APR, the less you will have to repay. Be aware that typically only 51% of borrowers achieve the headline interest rate on a product, as providers offer an APR based on your personal circumstances.
  • Early repayment charges – These are something to take into account if you feel you may be in a position to pay off your loan before the end of its term. See how much you would be charged for early repayment and compare the charge with those for other loan products on offer.
  • Total amount repayable – Look at the total amount you would have repaid by the end of the loan’s term. This will help you to understand the real cost of taking out the loan and make it easier to compare products.

Should I get a personal loan?

Whether you should take out a personal loan depends on your personal circumstances and what you need to borrow money for.

Circumstances when a personal loan isn’t the right fit:

  • If you are looking to borrow a small amount of money, then a credit card may be a better option, as not many loan providers will lend less than £1,000.
  • If you are unsure whether you could afford to make the same repayment every month, then you are better off looking at what credit card deals you can find.
  • If you are looking to borrow to cover sudden costs that can be paid off in a couple of months, then an overdraft or credit card would be more suited to your needs, as these typically don’t have a set repayment schedule or early repayment charges.
  • If you are looking to borrow a large sum of money, then a secured loan would be a better option.

A personal loan is a financial product for the middle ground. It offers a bigger loan than you would get on a credit card, but not too much. You’ll be tied to the loan for several years, but you will clear your debt by the end of the term if you make your repayments. It can also be used as a tool to consolidate debt. If you have debts spread across different forms of credit, you could use a loan to repay them and to fix your interest rate so you know what your monthly financial commitments are.

What to do before applying for a personal loan

First check your credit score. If you were to make a loan application and it be rejected because you have a fair or poor credit score, this could further impact your credit rating. You can check your credit score through free services offered by the credit rating agencies.

If you need to rebuild your credit rating, here are some steps you could take:

  • Register to vote – Make sure you are on the electoral register, as the credit rating agencies use this to see whether you are who you say you are.
  • Pay your bills on time – Demonstrate that you are financially responsible by not missing any payments.
  • Lower your debts – Financial providers look at how much debt you owe in total and base their decision on whether they think you can afford to repay the loan, so try to reduce the amount you owe.
  • Limit your credit applications – Multiple applications for credit can raise a red flag with credit rating agencies. Try to space out your applications or do ‘soft searches’ where you can.
  • Check for errors – Look to see whether there are any factual errors on your credit report and ask for them to be corrected.

Secondly, make a budget and calculate how much money you can afford to pay off each month. This will determine how much you can borrow and over how long. Be sensible about how much debt you take on.

Thirdly, check the product’s eligibility criteria. If a personal loan requires you to have a minimum annual income of £10,000 and you don’t, you could negatively impact your credit score by applying and being rejected.


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