5 things to consider before applying for a loan

Loans are a popular way to borrow cash. They can be used to help fund the cost of a large purchase, such as a new car, help you pay for a wedding, or even consolidate existing debts into one manageable monthly repayment.

How do loans work?

When you apply for a loan, you receive a lump sum of cash that you then repay in monthly installments over a set term.

If you’re applying for an unsecured loan, where you don’t need to use an asset as collateral, terms usually range from one to seven years, and you may be able to borrow between £1,000 and £25,000. Because the interest rate is typically fixed, you’ll know exactly how much you need to budget for each month.

A secured loan, on the other hand, lets you borrow a larger sum of money over a term of 25 years or more, but you must secure your loan against an asset such as your home or car. This asset is then at risk if you fail to meet your monthly repayments. Secured loans can come with fixed or variable interest rates.

Applying for a loan is a big financial commitment, which means it’s important to consider the factors below before deciding whether a loan is the right choice for you.

1. What do you need the loan for?

First, think about what you need the money for - this can help you establish whether a loan is the best way to borrow the funds you need.

Generally, loans are a good option for covering one-off purchases or funding projects such as major home improvements. But if you’re looking to cover emergency expenses or need to borrow smaller sums more regularly, other borrowing options such as a credit card are likely to be more suitable.

2. How much can you afford to repay each month?

It’s crucial to have a good understanding of how much you can afford to repay each month.

To do this, go through your bank statements and work out how much money you have coming in each month from your salary and any other income, and how much you spend on household bills and other expenses. This should give you a clear idea of how much money you have left over each month and how much you could afford to put towards loan repayments.

It’s important not to overstretch yourself financially because missing loan repayments can damage your credit rating and make it harder to get credit again in the future. Increasing the term of the loan can lower your monthly repayments, potentially making them more affordable, but bear in mind this means you’ll pay more interest overall.

3. Do you have good credit?

If you haven’t checked your credit record for a while, now’s the time to do so. Having a good credit score increases the chances of getting accepted for a loan, and it also means you’re more likely to qualify for a lower interest rate.

By contrast, if you have poor credit, you might find it harder to get accepted for a loan – you’ll certainly have fewer lenders to choose from and you’re likely to pay a higher interest rate, making your borrowing more expensive. You might also be offered a smaller loan amount than you were hoping for.

You can check your credit record for free with any of the three main credit reference agencies – Experian, Equifax and TransUnion. As well as looking at your credit score, you should check your report for any errors. Even simple things like a mistake in your address can affect your chances of getting credit. So, if you spot anything, contact the credit reference agency and ask for a correction.

4. Secured or unsecured?

Another important consideration is whether you want to apply for a secured or unsecured loan.

As mentioned, a secured loan requires you to use an asset – usually your home – as security. This means the lender has the right to repossess that asset if you fail to repay your loan. This increases the risk for you, the borrower, but lowers the risk for the lender. As a result, lenders tend to offer higher loan amounts for secured loans, and you’ll usually get a better interest rate too. This makes them more suitable for larger home improvements, such as an extension.

Secured loans tend to be easier to qualify for, which means you might want to consider one if you have bad credit. But if you do apply for a secured loan, it’s crucial to make sure your repayments are affordable.

Unsecured loans, on the other hand, don’t ask for security, making them less risky for the borrower. However, as the risk is higher for the lender, you’ll need a good credit score to qualify for the best interest rates, and you won’t be able to borrow as much as with a secured loan. Unsecured loans can be a good option for buying a car, paying for a wedding and consolidating debt.

5. What’s the cost of the loan?

When comparing loans, it’s important to consider the total cost of the loan, including whether there are any arrangement fees to pay, or whether you’ll be charged an early repayment fee if you decide to pay back your loan before the end of the term.

You also want to check whether the interest rate is fixed or variable. Unsecured loans typically offer a fixed interest rate, meaning your monthly repayments remain the same for the duration of the loan, and you can budget accordingly.

Secured loans may have variable interest rates, which means the interest rate and your monthly repayments could go up or down during the loan term, making it harder to determine the overall cost of the loan.

How to improve your chances of getting a loan

Before applying for a loan, it’s worth making sure your credit score is as good as it can be. You can do this by:

• Checking you’re registered on the electoral roll – lenders use this to verify you are who you say you are
• Paying bills and other credit repayments on time
• Paying down any existing debts.

It’s also best to space out credit applications by at least three months, preferably six. That’s because each time you apply for credit, like a loan, a hard credit check is carried out and this leaves a mark on your credit file. If you have a lot of hard searches on your credit file in a short space of time, lenders may believe you are struggling to manage your finances and may not let you borrow.

When you compare loans through us, we initially carry out a soft credit check that leaves no mark on your credit file and won’t hurt your credit score. This allows you to see which loans you’re more likely to qualify for, helping you to apply for your chosen loan more confidently.  

What are the alternatives to a loan?

If you don’t think a loan is the best choice for you, some of the alternative options include:

• ‍An overdraft: If your current account offers an arranged overdraft, you could use this to cover emergency expenses or other unexpected costs. However, overdrafts should only be used for the short term, as interest rates are generally a lot higher than loan rates.‍
• A credit card: Credit cards can help you spread the cost of a holiday or a one-off large purchase. You won’t be able to borrow as much as you can with a loan, but if your credit card offers a 0% purchase deal, you can avoid paying interest on your repayments for several months.‍
• Savings: If you have built up a savings pot, you could use these funds to cover an unexpected bill, such as car repairs, or even to pay for a holiday. You’ll then need to take steps to replenish your savings.

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