Legal advice

How to Choose the Perfect Loan?

By Christy Bella | December 22, 2020

Table of Contents

With so many loan products available, it is not uncommon for people to feel a little overwhelmed when contemplating their options. Now that you can complete applications online, there are so many lenders you can choose from, and you should take advantage of that by doing thorough research before committing to a loan.

Lenders offer various loans with differently structured repayment systems and interest rates. That alone makes it worth shopping around when you need a loan. However, the question remains: how will you know which one is best for you?

Understanding loan motivation

When you consider taking out a loan, your reason for doing so is a partial guide to deciding which option is best for you. This means examining why you need a loan and what you plan to do with the money. People’s loan needs vary greatly, with some requiring a little extra cash to see them through a crisis and others wanting to finance significant purchases, such as buying a home.

Before applying for a loan, consider the reasoning behind it. There are circumstances under which it is impossible to avoid debt. In these cases, you will need a loan, and choosing the right one is essential.

Loan categories

The two main loan categories are secured and unsecured loans. Secured loans require borrowers to offer collateral against the loan. These loans usually apply to large purchases, such as a house or brand-new car. The asset you buy is used as collateral in the transaction. If you default on loan repayments, lenders can seize that asset.

Unsecured loans do not require collateral. They are riskier propositions for the lender as there is no asset to repossess in the event of non-payment.

Amount required

The amount of money you need is another determiner of the type of loan you require. For example, a small loan of a few hundred pounds is best obtained from a payday lender. Personal loans are ideal if you need a few thousand pounds. Long-term loans, such as mortgages, are for substantial sums of money.

Repayment period

Payday loans are typically settled within a few weeks in a one-off repayment. Alternatively, you can arrange two or three installments with the lender if you have borrowed a larger sum of money. Personal loan repayment periods can last anywhere between one and seven years, whereas long-term loans can carry on for more than 20 years.

When you apply for a loan, most lenders give you the option of specifying how much time you intend to use for repaying it. Some offer a handy loan calculator that lets you work out how much your installments will be each month based on different loan periods.

Interest charges

Like any business, money lenders only offer their services to make a profit. They do so by charging interest on the sums lent to borrowers. Interest rates charged vary from one lender to another and relate to the type of loan you intend to utilize.

Secured loans come with a lower interest rate because there is collateral offered against them. They are regarded as less risky by lenders and a source of long-term income.

Unsecured loans are riskier, as the lender will have no assets to seize should you not pay the installments. Therefore, higher interest rates are charged to mitigate this risk.

When it comes to interest on loans, borrowers have two options: fixed-rate or variable-rate loans. With a fixed-rate loan, lenders have a set interest rate that they charge, and the repayment amount does not change for the loan’s duration. Variable-rate loans are linked to prevailing interest rates as determined by central banks. Should interest rates go down, the repayment amount decreases, and vice versa.

Central bank interest rates change according to market conditions. For example, they will be lowered during a recession or slowdown to stimulate the economy and mitigate the effects of inflation.

Lenders offer clients different interest rates. A difference of as little as 0.5% can make a substantial difference to your loan repayment amount. Therefore, examine the rates various lenders offer to find the best deal.

Credit check requirements

A lender is entitled to scrutinize your financial records to see your credit history and gain an idea of your sense of financial responsibility. Someone who has always paid their debts on time is regarded as the ideal candidate, who poses little or no risk to the lender. A person with a spotty credit history and judgments against them for bad debt is the opposite.

Payday lenders are more lenient when it comes to credit history and these loans are the ideal way to rehabilitate your credit score. Other lenders might still consider extending a loan to you, but they are likely to charge a higher interest rate or insist that someone with the good credit record co-signs the loan with you as a guarantor.