Taking out a personal loan is a big financial commitment, so it’s important to know what you can and can’t use it for.
Here, we discuss:
- what a personal loan is
- how they work
- how interest rates work
- what you can use one for
- what you can't use one for
- how credit scores impact your credit score
What’s a personal loan?
A personal loan is where you borrow money and pay it back over time. They come in two forms: secured and unsecured.
- A secured loan is where you borrow money while securing it against an asset. Securing means you risk losing an investment, like your car or home, if you can’t make the repayments.
- An unsecured loan is where you borrow without doing that. Not securing against an asset means you won’t lose anything if you can’t keep up with payments, but it will significantly impact your credit score and could lead to a County Court Judgement (CCJ).
Most personal loans are unsecured. Typically, the amount you can borrow is higher on secured loans.
For unsecured, you normally have more freedom on what you can spend the money on too, which is why some people call them all-purpose loans.
How do personal loans work?
For a personal loan, you must first apply to a lender. We have a step-by-step guide on how to do this.
A lender will look at your credit score as part of this process. This represents your credit history. You can read more about credit scores here.
Assuming you agree to their terms, you’ll get the funds deposited into your account. Learn what you need to do before applying for a personal loan here.
What’s the interest rate on a personal loan?
Interest is what lenders charge you for borrowing money. Personal loans will have an Annual Percentage Rate (APR) represents the amount of interest you'll pay annually on money you've borrowed. Learn more about APR rates and how their worked out here.
Interest rates vary depending on the lender, the amount you’re borrowing and how often you’re paying it back.
Some lenders offer low-interest personal loans, while others will specialise in secured lending – this is where you borrow money against an asset, which we discussed above.
What can I use a personal loan for?
Buying a car
You can buy a car with a personal loan.
It’s a good alternative to car finance if you don’t want to have mileage limits, risk losing it for missing payments and want to own it from the start.
We offer unsecured car loans if you feel they work for you.
Home improvements
You can use a personal loan for home improvements like adding a conservatory or fitting a new kitchen.
You may want to take out an unsecured loan if you don’t want to risk any assets when borrowing. If you have a good credit score, it may not be more cost-effective to take out an unsecured home improvement loan, especially if it adds value to your property.
Debt consolidation
Debt consolidation loans help you simplify your debts. It combines multiple debts into one, helping you manage your money.
You should get free debt advice before you consider one, as they’re not suitable for everyone. Learn more about debt consolidation and responsible lending here.
Big purchases
You can take out a loan for big purchases like new appliances, electronics or furniture.
As above, this can be worth it if it adds value to your home.
What can’t I use a personal loan for?
Starting a business
You should speak to your bank first about getting a business loan. This is better suited than a personal one, as it requires you to make a business plan and speak to a specialist.
Business loans are generally safer as you need a viable idea and evidence that it’s a worthwhile investment.
Paying the deposit on a house purchase
Getting money for a deposit is sometimes the most challenging part of buying a home. Mortgage providers will ask you how you’ve funded your deposit, and if the money’s from a loan or credit card, it could impact their decision.
Raising a deposit with borrowed money is seen as a significant risk, and it’ll count as one of your outgoings, meaning banks will consider it when reviewing your ability to repay.
Instead, you should try to save and use this as a deposit.
Investing in stocks or shares
The stock market’s volatile and difficult to predict. For that reason, borrowing to invest is considered risky and could leave you with significant debt.
Paying your household bills
Being unable to pay your monthly bills is stressful, and you could see borrowing as a potential solution.
However, this only moves the problem – it doesn’t solve it. Instead, we recommend getting free and impartial advice from an organisation like Money Helper.
How do personal loans impact your credit score?
A personal loan can both help and hurt your credit score. It all depends on taking out the right one and paying it back.
Assuming you pay on time, a personal loan can:
- improve your credit score
- build up your payment history
However, it also:
- leaves a hard search on your credit history, which may reduce your score in the short-term
- can build up debt
- lower your credit score if you miss payments
It’s important you know the pros and cons before you take out a loan.
