How do unsecured personal loans work?

An unsecured personal loan suits someone who knows how much they need, wants a fixed term and a predictable payment, and does not want to put a charge on their property. Common uses include home improvements, a car, or replacing more expensive borrowing.

Because there is no security, the lender prices the person rather than an asset. A clean credit file and stable income tend to attract the lowest rates a lender offers; adverse credit or high existing commitments move you up the price range quickly, and may reduce how much a lender will offer.

The rate a lender advertises is a representative rate: only a proportion of successful applicants have to receive it. The rate you are actually offered depends on your own circumstances.

An unsecured loan is one of several ways to borrow, and the right choice depends on the amount, the time you need to repay it and the risk you are willing to take.

• Credit card or 0% card — revolving credit with no fixed end date. A 0% purchase or balance transfer card can be cheaper for a short, disciplined payoff, but the rate rises once the promotional period ends.
• Unsecured personal loan — a fixed amount, fixed term and fixed payment, with nothing secured on your home.
• Secured loan — borrowing against your home. It can allow larger amounts and longer terms, but your home may be repossessed if you do not keep up repayments.
• Overdraft — convenient for short-term gaps, but usually an expensive way to borrow over longer periods.

• Credit file — missed payments, defaults, CCJs, the number of recent credit searches and how much of your existing card limits you are using.
• Income and employment — employed, self-employed and some benefit income can all be considered, though the evidence required differs between lenders.
• Existing commitments — the new payment plus what you already pay has to be affordable. This is why two people on the same salary can receive different offers.
• Address history — being on the electoral roll at your current address helps identity checks. A thin credit file is a different problem from a damaged one.
• Each lender sets its own eligibility criteria, including minimum income and residential status, so check them before you apply.

A full application usually involves a hard search, which other lenders can see. Several declined applications in a short period can make the next lender more cautious.

Many lenders and comparison services offer eligibility checkers that do not leave a mark visible to other lenders. Using them first, then making one full application to a lender likely to accept you, is usually better than applying to several and hoping one says yes.

A longer term lowers the monthly payment but increases the total interest you pay. Look at the total amount repayable before choosing a term.

Some loans charge for repaying early; check the terms if you might want to settle the loan ahead of schedule.

If you are worried about keeping up repayments, MoneyHelper (moneyhelper.org.uk) offers free, impartial guidance on borrowing and managing debt.