Loans Knowledge Hub

Types of loan FAQ

Looking for a loan? Unsure which kind best suits your circumstances? We round up the main types of loans available on the market.

What is an unsecured loan?

An 'unsecured loan' is a personal loan that is not directly connected to your assets. The issuing of the loan is completely based on the borrower's credit profile and economic circumstances. Unsecured loans are typically offered with term lengths between one and seven years, and with borrowing levels up to £25,000. However, some lenders set the maximum borrowing level at significantly less.

If you default on a personal, unsecured loan, your home is not at risk of being repossessed to meet the repayment, unless it is part of a wider, more complex portfolio of financial arrangements that do include personal liability implications.

Unsecured loans are offered through traditional banks and building societies as well credit unions and specialist lenders. Although the term 'unsecured loan' is associated mostly with traditional personal loans, it technically applies to payday and short-term loans too, as well as any other loan that is not asset-backed. Unsecured loans are generally more expensive than secured loans.

What are secured loans?

A 'secured loan' is a personal loan that is tied to an asset, such as your house, vehicle or other property. If you default on a secured loan, the lender can repossess the property put up as collateral in order to recover the debt that you owe. Secured loans often offer higher lending limits than unsecured loans, depending on the equity level that you hold within the asset. As such, secured loans can be used to free up equity from your home without selling it.

Because of the added security offered to the lender, secured loans are usually cheaper than unsecured.

What are payday loans?

A 'payday loan' is a short term lending instrument designed to fill a financial void before your next regular instalment of money.

A typical payday loan is expected to be paid back within a pre-agreed period of between one and 30 days, though the payback periods vary from lender to lender. At the end of your agreed term you must pay back the original amount you borrowed plus the interest accrued.

Payday loans are for smaller amounts of money than you'd usually be able to borrow through a more traditional personal loan. Between £25 and £1,500 is typically offered, subject to credit checks.

The benefit of a payday loan is that the borrower does not have to enter into long term borrowing arrangements, with the obligation to continually make incremental repayments and with interest accruing over time. The decision process is also very fast. For this reason, payday loans are sometimes called 'same day loans', 'instant loans', 'fast cash loans' or some combination of those and other terms.

What we commonly now refer to as 'payday loans' carry much higher interest rates than other comparable forms of lending, often hundreds or thousands of per cent higher than the most competitive personal loans, credit cards, overdrafts and credit union loans.

What are short term loans?

'Short term loans' refers to the lending of relatively small amounts over a matter of months. Instalment loans are examples of short term loans. The interest rates attached to these products can be thousands of times higher than with traditional personal loans.

Credit unions also offer short term loans, but at much lower interest rates than short term or instalment loan providers.

What are bad credit loans?

'Bad credit loans' are loans that are made available to individuals that have insufficient credit profiles to access regular lending products through traditional routes. This can be either because they have experienced financial difficulties in the past and have defaulted on previous arrangements, or because they have not had enough experience of managing debt-based products.

Bad credit loans usually carry higher interest rates to lower the risk of the lender's losses in the event of a default.

They are sometimes offered by high street banks and building societies, but are more commonly provided by smaller, specialist lenders.

Short-term loans, instalment loans and logbook loans can often also be classed as 'bad credit' loans because their providers will sometimes lend to people that are unable to access loans through traditional channels such as banks and building societies. Short term lenders contend that they are able to do this because their algorithms in assessing credit worthiness are more complex, although the risk profile that the lender adopts will also be a factor.

What are credit lines?

Credit lines (or 'lines of credit', or 'credit accounts') offer flexible access to borrowing over a period of up to year, although some lenders cap term lengths at a few months.

The accounts are a unique form of lending, although they share various traits with credit cards, overdrafts and pay day loans. Account holders usually administer the account online or over the telephone, transferring cash to their current account as they need it. They can draw credit from their allowance whenever they choose within their term, and in any increments up to their agreed limit.

Credit Lines are available for both individuals and small businesses. Individuals can generally borrow up to around £1,000 - although smaller and larger maximums are available from different lenders. Businesses can borrow tens of thousands through some providers.

Credit lines are an expensive way to borrow compared with credit cards and overdrafts. Interest rates can be thousands of per cent when expressed as an Annual Percentage Rate (APR). Failure to pay off the debt within the agreed term can lead to rapidly escalating compound interest and serious financial consequences.

Eligibility for credit lines is dependent on your credit profile, although some providers advertise that they can offer services to those who have suffered financial problems in the past.

What are logbook loans?

A 'logbook loan' is a type of secured loan where your vehicle - such as a car, van or motorbike - is put up as collateral against the debt. The logbook loan lender takes ownership of your vehicle until the loan is repaid. However, while the lender takes possession of the logbook and other ownership documents, the vehicle will be 'loaned' backed to you so that you can continue to use it. When the monetary debt is repaid, the ownership of the vehicle is transferred back to you.

You can usually borrow up to half the market value of your vehicle. However, if the vehicle depreciates in value during the loan term and, in the event of a default, the sale does not cover the outstanding debt, including accrued interest, the borrower will still be liable to meet the shortfall.

A potential benefit of logbook loans is that they can offer lending to those with poor credit histories who would be refused loans elsewhere.

What are guarantor loans?

A 'guarantor loan' involves a third party - such as a parent, legal guardian or employer - agreeing to meet the monthly repayments or pay off the loan completely in the event that the borrower defaults. The guarantor will be legally bound to comply with the terms and conditions agreed to and can be subject to court action and debt recovery measures if they fail to do so.

Because of the added security to the lender, guarantor loans can sometimes enable the borrower to obtain cheaper interest rates than they would be able to without it. The arrangement can also enable people with poor or limited credit histories to obtain lending if they are unable to do so through other routes.

Guarantor loans are offered through traditional high street banks and building societies, as well as credit unions and other specialist lenders.

What are car loans?

The term 'car loans' is variably and interchangeably used to refer to both traditional personal loans that are used to buy vehicles and hire purchase schemes. The two are different forms of lending.

Traditional personal loans can be obtained through high street banks and building societies and specialist lenders, on secured or unsecured terms, for the express purpose of purchasing a car or other vehicle. There are usually no differences in the mechanics or cost of a personal loan for a vehicle compared with for any other purchase. However, there are specialist lenders who focus only on providing personal loans for vehicles.

Hire purchase schemes are usually arranged through vehicle dealerships. They typically require an upfront deposit followed by monthly repayments. However, the car does not belong to the borrower until the agreed term is finished. With some hire purchase schemes, the monthly repayments throughout the term will have been enough that the car is owned outright by the borrower. With others, the borrower will have cheaper monthly repayments but will need to make an additional bulk payment at the end of the agreement if they wish to take the ownership of the vehicle. Unlike in the case of a logbook loan, borrowers signing up to a hire purchase scheme have their consumer rights protected under the Consumer Credit Act 1974.

What are peer-to-peer loans?

'Peer-to-peer loans' are a fairly new lending instrument that have joined the market in recent years. They refer to money lent and borrowed between individuals or small businesses, rather than involving traditional financial institutions like banks and building societies. Internet-based companies act as the facilitator for the deals.

Available for any amount of money, over varying term lengths, the benefit of peer-to-peer loans is that they can offer more favourable interest rates than either party could achieve through traditional routes. This is because the role of the third party facilitator is greatly reduced and its margins are smaller.

The negative is that the money individuals lend through peer-to-peer loans is not covered by the Financial Services Compensation Scheme as it would have been if it had have been invested in savings accounts.

However, individual's investments can be spread among multiple different loans to hedge risk, and individuals can choose the level of risk they are amenable to. The facilitators of peer-to-peer loans also take steps to verify that borrowers are credit-worthy and will help to recover debts that are defaulted on.

There are different types of peer-to-peer loan set ups for individuals and businesses.

What are business loans?

The term 'business loan' usually refers to lending for small or startup business. They can range from as little as a few hundred to tens of thousands of pounds.

Under some arrangements, usually for micro startups, the individual business owner that takes out the loan can do so on an unsecured basis, meaning they are personally liable for the repayment. For established businesses, secured loans can be obtained with business assets such as premises, machinery or vehicles placed as collateral. Depending on the way that the business is structured, liabilities can be limited to the business, with the directors' personal assets safeguarded. However, lenders can add clauses of personal liability to most agreements with small business owners.

Business loans are usually issued through lenders' retail banking arms, which also offer financial services to individuals, such as personal loans, mortgages and current accounts. Funding for larger companies usually falls under the lenders' corporate divisions.

Peer-to-peer loans for businesses are also available.

What are instalment loans?

The term 'instalment loan' technically refers to any sort of loan that is repaid through multiple, scheduled increments. This includes traditional personal loans and mortgages. However, in recent years the term has become more regularly associated in the main with short term loans that are paid back in a small number of instalments.

These types of loans are offered by start-up companies akin to the ones that offer short term loans, albeit sometimes with lower interest rates. They are also offered by credit unions who offer significantly lower interest rates.

Borrowers can typically access anywhere from £100 to around £1,500 which they can pay off over a period of between two and twelve months. Longer terms are available.

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Written by Peter Adams

    Published on 28-06-2018

    Updated on 29-01-2020

Peter reports on a number of areas in the personal finance sector, with a particular interest in supporting businesses and individuals in the UK services industry.

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