Unsecured lending, the facts

An unsecured loan is a contractual agreement where you agree to repay the capital and interest of the amount borrowed on set dates for a set period of time. The lender does not seek additional security ion the form of a charge over your home or any other assets that could be seized should you fail to pay.

Typically, you may borrow, say, £5,000 and repay this in 60 monthly instalments of around £100 per month. That equates to repaying the capital of £5,000 plus a charge for borrowing of around £1,000. There may also be acceptance or administrative fees added to the first instalment.

Comparing loans is made a little easier since the introduction of the Consumer Credit act in 1974. All loans have to take into account the total cost of credit when working out the Annual Percentage Rate (APR) of interest. This means that if any fees are added, the rate quoted must include them so you can see the full cost of borrowing.

Small loans tend to be repaid over relatively short periods of time. If you borrow to buy a car, then the repayment period will be linked to the useful expected period that you will keep the vehicle before looking to replace it. This helps you to budget and reflects the loss in value of the vehicle over time. If the car is new then you will almost certainly have the flexibility to borrow the money over a five year term. If the car is older then the repayment period may be limited to two or three years.

The loan agreement is a promise to repay. There is no additional security or charge over property or other assets taken so if you fail to keep up with your repayments you will be sued by the lender for the balance outstanding (plus late charges and administration costs). If you have acquired a car or other valuable asset with the loan then you may consider surrendering this in part or full payment for the loan. You will most likely get a better price if you sell yourself rather than surrender it to the loan company since it will almost certainly be auctioned.

Unsecured loans are used by borrowers to fund a multitude of activities and assets from cars, motorcycles and caravans to weddings, holidays and cosmetic treatment. They can even be used to pay for small home improvements.

Although the lender may not look for security before granting the loan, they may look for you to provide either a co-borrower or guarantor. This means that if you fail to pay then they can look to the joint borrower or guarantor for payment instead. This may be the case where the borrower is young and has a limited credit history or where there is some evidence of bad payment in a credit history.

Most short term loans will be made on the basis of a fixed rate of interest. The interest portion of the loan is known and fixed at the outset for the whole period of the transaction. Loans for periods in excess of 5 years may become increasingly variable in their interest element with a rate charged linked to an index such as Bank Base Rate. That means that if rates go up, so will the interest element charged to you. Conversely, if interest rates fall, so will the interest element of the payment. The capital portion of the repayment will always remain the same.

The amount you can borrow on an unsecured basis varies and it depends upon a number of factors such as your salary, credit history and purpose for the loan. As a guide, amounts up to £7,500 will probably be on an unsecured basis for most – good credit quality customers and those with high incomes may well be able to borrow up to £25,000 or more. Once the loan exceeds £15,000 the majority of borrowers will be looking at a loan that is secured on their homes.

There are any number of loan comparison websites that will give a basic indication of what can be borrowed and the terms that might apply for good, average and poor credit customers. Look for a low APR and make sure to check for early redemption penalties if you think that you might want to repay the loan early. The lowest APR might not be the best overall deal for you so be sure to research your needs. For example, taking a dealer or manufacturer low rate loan with which to purchase a car may seem like a good deal, but getting extra discount on the car and a low rate loan from a bank may work out cheaper.