Loan types explained

Borrowing money can be a hassle-free way of getting your hands on some much-needed cash. But when it comes to getting a loan, there are lots of options to choose from as well as a number of potential pitfalls.

Here’s our guide to the different types of loan available.

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Personal loans

Aside perhaps from mortgages, this is the most common type of loan – when you see loan adverts or best-buy tables, they are generally referring to personal loans.

This is a loan for a specific sum borrowed over a certain period – usually between one and five years – at a fixed rate of interest. Borrowers repay a fixed amount every month until the loan plus interest is paid off.

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Secured loans

A secured loan is one which uses a borrower’s asset – such as a home or car – as security. This means that the lender has a claim on the asset if the customer misses repayments or defaults. A mortgage is a secured loan, for example, but personal loans are unsecured so borrowers are not at risk of losing any assets if they can’t make repayments.

Bridging loans

A bridging loan is usually a short-term loan aimed at filling the gap between buying a property and receiving the proceeds from the sale of another one. This kind of loan tends to be taken out by property investors or buy-to-let landlords.

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Peer-to-peer loans

Over the last few years, a new kind of financial product has emerged, known as peer-to-peer lending. This is a web-based service where individuals with spare cash lend it to other people.

The idea is that, by cutting out the banks, lenders get better returns and borrowers get cheaper loan rates. From a borrower’s point of view, taking out a personal loan from a peer-to-peer service such as Zopa or RateSetter is no different from borrowing from a bank, and rates do tend to be competitive.

How does peer-to-peer lending work?

Payday loans

These are very short-term loans aimed at people who are struggling to afford everyday expenses at the end of the month. Payday loans and lenders have come in for a lot of criticism over recent years due to the high rates of interest they charge and the penalties borrowers face for late repayment.

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Overdrafts and credit cards

These are types of loans which are agreed in principle in advance – subject to certain limits – and which borrowers can use when they want.

Both are often very convenient ways of borrowing, but charges and interest costs can be very expensive. This is particularly the case for unauthorised overdraft borrowing (that is, going above the pre-agreed limit).

Next article: Discover the most costly credit card errors  >>>

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