Loans come in lots of different ways. Some can be a good idea in the right circumstances. While others can be a lot riskier and you should do your best to avoid them.
Here we’ll break down what a loan is and some of the different types you might come across.
What is a loan?
A loan is when a bank or other lender lets you borrow an amount of money, with an agreement that you will pay it back.
They come with a term, which is a timeframe that you need to pay the money back within. They also often carry an interest rate, this is a percentage of the original amount that you also need to pay back on top. There may be other fees and costs attached to a loan.
Risks involved
Before thinking about getting a loan or applying for one, it’s important to know about the risks.
Repayment
Whenever you borrow money from someone else, one of the main risks is that you may not be able to pay it back when agreed. Lenders can charge you fees if you miss repayments and over time interest can also make the cost of the loan more difficult to manage.
Fees
Another risk is fees that you might not be aware of. There can be upfront fees included with the cost of taking out a loan that you might not have considered. There can also be fees for things you might not expect, such as early repayment.
Loss of assets
For some loans, you will have to secure it using something you own, like a car or a house, as collateral. This is an asset that a lender can take from you if you fail to meet the terms of the loan.
Debt
Getting into debt is another important risk to think about. If something goes wrong and you miss a few payments, you could quickly find yourself owning more money than you can afford to pay back. Your debt can end up with a debt collection agency. They go to a lot of effort to try and recover some or all of what you owe, including taking legal action.
Credit score
Your credit score is a number you get based on factors such as your financial history. Lenders use it to work out whether they are happy for you to borrow money. If you have difficulty paying back a loan, this can hurt your credit score. It’s important to try and keep a good credit score. This can help you for things such as getting a good deal on a mortgage when you want to buy a house.
Managing risks
If you are taking out a loan, there are ways that you can manage these risks to try and protect yourself.
First, you should read the terms and conditions carefully. This will help you understand all of the information that you need to know, such as:
- How much you’re borrowing
- The interest rate
- The repayment schedule
- Any upfront fees
- Any other fees you may be subject to
Before you take out a loan, you should work out your budget. Figure out what income you have coming in each month and what expenses you have. This can be things like rent and household bills, subscriptions you pay, food and shopping for the month. This way you’ll have a good idea of what you can afford to pay back.
You can use Money Helper’s loan calculator to help you work how long a loan will take to pay off and how much extra you’ll be paying in interest.
Common types of loan
Student loan
This is a loan you can get when going to college or university. You use it to help with living costs and fees for your course, known as tuition fees. The Student Loans Company grants these and they’re given out by the Student Awards Agency Scotland (SAAS).
You can find out more about who can get a student loan and how much you might receive on the SAAS Key Facts page.
You don’t have to start paying back a student loan in Scotland until you earn at least £27,660 per year.
You can find out more about repaying your student loan on the SAAS website.
Overdraft
An overdraft is a feature of your current account that lets you spend beyond what you have in your account. Your overdraft may be ‘authorised’ which means you have an agreed limit with the bank that you can spend up until. Or, it can be ‘unauthorised’. This means you have gone beyond what is in your account without having an agreed overdraft.
Your bank may let a transaction happen if you don’t have enough money or an overdraft so you can pay for things like bills.
There may be interest and other fees that come with having an overdraft. Learn more on the Money Helper site.
Mortgage
A mortgage is a loan that helps you buy a house. For most people, it is unlikely you will have enough money to buy a house upfront. Instead, you can put down a deposit that lets you take out a loan to cover the rest of the cost. You then pay this back plus interest and other fees over a long period of time, on average 25 years, in monthly payments.
Get more information about mortgages and saving to buy a house in our article.
Car finance
You can take a loan out to buy a car.
Finance companies can agree a deal with the person or company selling a car that lets them cover the cost. This means you can buy a car with the agreement that you pay back the amount owed plus interest to the finance company.
Learn more about the different types of car finance deals on the Which? website.
Personal loan
This is also known as an unsecured loan. This means you borrow money from a bank or other lender without securing it against an asset, such as a car or a house.
These come with a term to pay back within, an interest rate and may have other fees such as an early repayment charge.
Learn more about personal loans on the Money Helper site.
Secured loan
A secured loan is usually for a large sum of money of around £10,000 or more. You can take a secured loan out from a bank or lender if you secure it with an asset in case you fail to pay it back. This can be your home, car or other valuables you own.
The risk is high as you stand to lose a lot if you fall behind on repayments.
Learn more about secured loans and the risks on the Money Helper site.
Payday loan
These are short term loans. The term comes from the fact the loan is to support you to get by until your next payday.
Usually you borrow money for a month, but you can do so for longer periods of time such as three months or more. The costs that come with payday loans are very high and these can be very risky. If you can’t pay back what you owe you can quickly end up with much more debt than what you borrowed.
Payday loans are regulated in the UK to try and protect you from predatory practices. However, you should consider other options available to you if you are thinking about taking one out.
The Money Helper site has a handy article with other ways to get support instead of taking out a payday loan.
Buy Now, Pay Later
This is another type of loan where you borrow money to buy something and you can pay what you owe back over time. These often have no interest attached which can make them seem appealing. However there are risks attached to these, as with any loan.
Watch our Iona Explains… Buy Now, Pay Later video for more information.
Other support available
It may be tempting to turn to a loan as a way of getting extra money to help you get by. However, there are other ways to get support that are less risky.
You may be entitled to benefits, check out our article showing what is available in Scotland.
If you need support with debt you can contact the National Debtline for free, impartial advice and support.
Chat to them online. Or, call on 0808 808 4000, Monday to Friday 9am to 8pm and Saturday 9:30am to 1pm.
You can also find useful information on managing debt the Money Helper site. Or, check out their article on other ways to borrow.