Personal loans
What are Personal Loans
These personal loans can be either secured or unsecured. A secured personal loan means the bank has secured the money it lends you, on either the item you are buying or some other item of value, known as collateral.
Secured personal loans should charge a lower interest rate than unsecured loans because the risk of the bank losing its money is lower. This is because if you can’t pay the secured loan off, they will take the goods secured against it, sell them, and get their money back that way.
Unsecured personal loans are more expensive, as the banks would lose their money if you didn’t pay back the loan, and they couldn’t force you to make payment any other way.
Financially literate people understand how loans work, and try to avoid using them if at all possible. They know they will always end up paying back far more than they originally borrowed, once the bank's interest is added.
To make it easier to compare the cost of different personal loans, loan companies have to publish a % figure known as the APR or Annual Percentage Rate. This should show you how much the loan will cost in total, including any setup fees or hidden charges. The lower the APR figure, the better it is for you, if you really must borrow. A personal loan with an APR of 2.99%, is far better value, than a loan with an APR of 9.99%. The difference can be subtle, but it's significant.
Payday loans
Although not sold by banks, it is worth mentioning payday loans just quickly, as these are the most expensive loans of all.
The interest rates can be eye-watering and can run into the hundreds of per cent per year. Indeed, a few years ago, some of these firms APR’s exceeded 1,000%. The regulators had to bring them into line!
Although these loans are marketed as just being for the short term, or emergency loans, so from one month to the next, the only advice I can give you about them is, try not to take one out if at all possible. See the dangers of credit.
Personal Mortgages
A mortgage is the name given to a large secured loan for the purpose of buying property. This is really the only type of debt I would suggest you take out, as it is practically impossible for anyone other than the super-rich, to buy a house or flat without some sort of financial help by way of a mortgage loan.
Interest rates on mortgages will be higher than the interest rates you can get on your savings accounts, but lower than personal loans. This is because the loan is secured against your property, and if you fail to pay the loan back, the banks can and will take your house, sell it, take what they are owed, plus some extra fees of course, and give you back anything that’s leftover. This is called a repossession, and you must avoid this at all costs.
Mortgage interest rates are usually pegged to the Bank of England base rate, so this is a key part of both mortgage and house affordability. UK and worldwide interest rates have been comparatively low for the last decade or so, following the financial crisis, and therefore mortgages have been available in the 2% - 5% range for most people.
This hasn’t always been the case. My very first mortgage deal was set at a whopping 15%! And that included a 1% special discount for the first year only. This rate seems quite extreme now, but at the time, in the late 80s, the Banks base rate was running at between 12% - 15%, and so this was quite a “good” deal.
These high rates are not likely to return any time soon, but the fact remains, they did happen, and so could happen again at some point in the future.
FACT: The word mortgage means “death pledge” in old French and Latin. This could be interpreted as owing the debt until death, although mortgage terms are more usually 25 to 30 years nowadays.
Your credit score
Financial institutions providing mortgages and loans, will look at, and consider your credit score when you apply to borrow money from them. This score, which is quietly and secretly being calculated in the background on you, by the rating agencies, is very important if you do want to borrow money at a reasonable rate, and certainly essential if you ever plan to be a homeowner in need of a mortgage.
Rating agencies use slightly different rating systems, but the general principals are all the same. Low scores or the red band indicate a poor risk for the banks. Medium scores or an amber band indicate a medium risk. High credit scores or a green band indicates a good risk for the banks.
Unsurprisingly, good risks are offered loans with better rates, whereas poor risks will either be declined outright, or have to pay a higher interest rate to compensate the banks for the increased risk of default.
To build a good credit score, it is important to pay back all loans on time and in full. This includes credit you use with catalogue shopping or in-store cards, plus any other buy now pay later deals you take on. If you don’t pay back money owed or are often late in paying back instalments, then this is recorded and adds to a negative score with your credit rating.
TIP: You can usually find out your own credit score, by asking the rating agencies such as Experian or Equifax directly.