Loans

There are many types of credit available; a loan is one way of using credit sensibly. There are many ways of receiving a loan, and many ways of paying it back depending upon your situation. If you receive a loan from a friend or relative it is likely that you will agree to repay them as and when you can afford it. This is an informal type of loan which is based on a mutual trust between you and the lender. If you receive a loan from a bank, moneylender, or other institution there will be a formal written agreement between you. This agreement will state things like the terms of the loan, how much and how often the repayments are, the interest rate and charges or fees you will incur. Below is an example of how much extra you will have to pay from getting your loan through the bank:

If the bank has agreed to lend you £5,000 there will be an arrangement fee of £100, with interest charged at 8% over the life of a loan. The life of a loan is five years and repayments will be £119 a month. Over the five year life of a loan you will have paid back a staggering £7,140 in total, adding £2,140 in interest and charges.

Let’s take a look at how this is broken down:

• Your loan fee is £100
• The interest is (£5,000 + £100) x 8% x 5 (years) £2,040
• Total £2,140

So your monthly payments over the five years (60 months) would be:

• £5,000 + £2,140 / 60 = £119
• [£5000 (original loan) + £2140 (fees and interest) / 60 (months)]

It may seem like you’re paying some hefty extras for taking out a loan, but like any other form of credit a loan will help you to pay for something you could otherwise not afford. Don’t make the decision of taking on a loan lightly – consider whether you could be patient and save up the amount you need. This way you won’t owe money to anyone and will be able to avoid paying the extra costs of interests and charges. For smaller amounts this is quite a realistic target to set yourself, but for bigger items this is sometimes not an option. For example if you chose to keep saving for a house instead of taking out a loan, the price of the house would probably go up much quicker than your savings and you could never afford it!

There are two different types of loans available to you, secured and unsecured.

Secured Loans

'Secured borrowing' means a lender has a 'legal charge' over some property of yours. If you stop your repayments the lender can possess that property and sell it to get their money back.

An example of a secured loan is a mortgage. The lender will give you money to buy a house, but they have a legal charge over the house. If you cannot keep up repayments and cannot get money to repay the lender from anywhere else, the lender may have no choice but to repossess the house.

Unsecured Loans

'Unsecured borrowing' means a lender will take no security. The bank or finance company who offer you the loan believe that you will be able to keep up your repayments.

An example of an unsecured loan is taking out a loan for a holiday. Your bank will be prepared to give you this loan on the basis that you have a good credit record and will normally have sufficient income to keep up repayments.

The cost of a loan will vary, but it consists of the total interest charged over the whole period of the loan, plus any charges or fees (which you will pay at either the beginning or the end). You should take into consideration what it will cost you to take on a loan, as well as looking at other points that will affect your decision:

• Make sure that you are fully aware of and understand the interest rate (APR) and charges connected with the loan before you decide to take it.
• Make sure you know how long the loan is for and how long it’s going to take you to pay it off.
• Do not get a loan from the first bank/finance company that you go to. Shop around and find the best deal that will work for you.
• Don’t assume that what your bank charges you for an overdraft will be the same as what it will charge you for a loan. Find out the individual charges.
• Also, interest rates on a long-term secured mortgage will be much lower than on a short-term crisis loan to someone with previously bad credit history.