How do personal loans work?

Looking to apply for a personal loan but want to know more? Find out how they work and how you can apply. Whatever you’re looking to take out a personal loan for – to finance a new or used car purchase, consolidate debt, pay for a holiday or even cover wedding costs – there are a variety of personal loans to choose from. Use the guide below to help you choose the right one for your needs and situation.

How do personal loans work?

Personal loans work in very much the same as any other type of loan. You borrow a certain amount of money from a bank or lender so that you can pay for the things you need to. You will have an agreement with the lender to pay back your loan in regular repayments – normally monthly.

Essentially, a personal loan helps you fill a short-term or medium-term need for finance – they typically cover periods of up to seven years. You apply for a loan from a lender who then assesses your suitability for the loan, and if you are approved the lender will send you the funds for the loan. Each of your repayments will cover part of the capital plus the interest accrued so far. If you make your repayments as set out in your loan contract, your entire loan will be repaid when your loan term ends.

The personal loan process

Step 1: Comparison

Finding the right personal loan is the first step of the process. But how should you compare them? There’s more to it than the APR. Here are some key features to compare:

• Loan amounts

  Each lender sets its own minimum and maximum amounts that it’s prepared to lend. So before diving into the T&Cs, check the amount you can apply to borrow. Is it enough?

  £25,000 is the standard ceiling, but some banks will stretch as far as £50,000 if you hold your current account with them. Specialist lenders, who focus on loans for those with a less than perfect credit history or those with particular circumstances (such as being self-employed, unemployed or retired) may have a lower limit.

  If you’re looking to borrow more than this, you’re probably going to need to look at a secured loan – that’s a loan where an asset (normally a property) is used as collateral. This could mean remortgaging or taking out a second-charge mortgage. Bear in mind a secured loan will put your house at risk if you were to default on payments. If you’re looking to borrow a smaller amount, you might want to compare 0% purchase credit cards as well as personal loans.

• Loan terms

  What are the minimum and maximum loan terms? Terms of between one and seven years are the norm, but expect this to differ between providers. It’s normal for providers to offer different loan amount ranges and different rates depending on the term of the loan. For example, some lenders won’t offer a £1,000 loan over 7 years.

  Broadly speaking (although there are exceptions) the longer you borrow for, the lower your regular repayments will be, but the more your loan will cost overall.

• Fees

  Check for upfront fees such as “set-up” or “product” fees and ongoing fees such as annual fees. Set-up fees can normally be paid upfront or incorporated into your loan amount (in which case you’ll pay interest on them).

• Interest rate

  When we talk about unsecured personal loans, these are generally fixed-rate products, but you should always check this before taking out any loan. With a fixed rate, your monthly repayments will remain the same for the duration of the loan, and you’ll know in advance exactly how much it’s going to cost you overall.

  A loan’s Annual Percentage Rate (APR) is a great benchmark for comparison, but what exactly is it? Well, this figure is designed to provide an annual summary of the cost of a loan. It takes into account both interest and any mandatory charges to be paid (for example a set-up fee) over the duration of a loan. All lenders must calculate the APR of their products in the same way, and must tell you the APR before you sign an agreement, so for consumers it can be a handy tool for comparison.

  Bear in mind, however, that lenders are only obliged to award the advertised APR to 51% of those who take out the loan – the other 49% could be charged a higher rate of interest. That’s why it’s often referred to as the “representative” APR.

• Repayments

  Here’s the crucial bit: your repayments need to be affordable. When considering your loan application, as well as checking your credit score lenders will look at your income and expenditure to see if the loan is affordable. More importantly, you’re going to want to know that it’s affordable for peace of mind.

  Remember that rule of thumb that, in general, the longer you borrow for, the lower your regular repayments will be, but the more your loan will cost overall. Aim to strike a balance and find a loan that’s affordable but isn’t going to cost you the earth overall.

  It’s also a good idea to aim to align repayments with your paydays, if possible, so check if the lender allows you to do this.

• Early repayment

  Can you repay the loan early without penalty? Normally, you won’t be charged extra to pay some or all of your loan off early. However, not being charged extra isn’t the same as saving money on interest. This is a feature where you might have to look quite closely at the loan terms. Realistically, some lenders don’t make it easy to make early repayments or overpayments, and, when you do, they continue to charge interest on the amount overpaid for up to two months. Tut tut.

Step 2: Eligibility

Lenders have set minimum eligibility criteria for their personal loans. This can include any of the following:

• Age. You will need to be 18 to apply for a loan. Some lenders may require you to be over 21.
• Income. You may need to earn over a certain amount to be eligible to apply for a loan. This will normally be verified by the last three months’ payslips, bank statements and/or a tax return.
• Employment. While most lenders will require you to be employed, some will consider unemployed applicants. Some lenders will require you to be out of your probation period with your current employer.
• Residency. You will normally have to be a UK citizen or permanent resident to be eligible for a personal loan.

However, even if you meet the minimum requirements for a loan you will not be approved unless you can prove you can afford the repayments. Lenders determine this by looking at your income, expenditure, outstanding debts, credit history and the stability of your employment.

Step 3: Application

The application process for a personal loan differs between lenders. Generally, you will have the option of applying online or in-branch (if the lender has branches) or over the phone. You can find a list of documents and information required to complete the personal loan application on finder.com review pages and on the lender’s website. It’s likely to involve some or all of the following:

• Proof of ID. Such as an acceptable form of photo ID, such as a passport or drivers licence.
• Proof of address. Such as a recent bank statement or utility bill.
• Proof of income. Depending on the lender, you’re likely to need three months of payslips and bank statements or two years’ of tax returns if you’re self-employed.
• Other financial documents. If you have other debts, such as loans or credit cards, you may need to show statements from those accounts.

Online applications usually take about 15 minutes to complete.

Step 4: Approval

Some lenders can give you an answer instantly while others may take a few days to approve you. There are two forms of approval: full approval or conditional approval.

Conditional approval usually takes less time but is given pending more information from you, such as additional payslips or documents relating to your assets or debts. Lenders may just ask for this information and not offer any conditional approval. This is to help them make a more informed lending decision.

Full approval is given when you have supplied sufficient information for the lender to make a decision the lender has approved you for the loan.

Step 5: Loan funding

Your loan can be funded in different ways depending on the type of loan it is and what you are using it for. For example, when you take out a car loan the lender may pay the car seller directly. This is often the same case with a debt consolidation loan as well, with the lender directing funds to your debtors directly rather than to you.

More commonly, if the loan is an unsecured personal loan, the funds will be sent to an account you nominate. Some lenders can transfer funds on the same day you apply while others might take a few days following approval.

Step 6: Repayment

Most lenders will allow you to choose the day on which repayments are taken. Some may even allow you to opt for weekly or fortnightly repayments, but may charge extra for this service. Generally, the more often you repay your loan the less interest you will pay. When choosing your repayment structure you may also want to consider additional and early repayments.

• Find out if your lender will charge fees for additional repayments.
• Check if your lender has restrictions on how much you can repay extra per year.
• If there’s a chance you could repay early, check if doing so will actually save you money on interest.

Some personal loans incorporate an optional “repayment holiday” facility, for example a two month gap at the start of your loan. Just bear in mind that your debt will continue to accrue interest during a repayment holiday, making a loan more expensive overall.

Step 7: Loan closure

If you are simply making your repayments as set out in your loan contract, then your loan should be closed following your final repayment. However, if you are planning to repay your loan early, it’s a good idea to call the lender and get a final settlement figure before you do so. This is to ensure the loan will be closed when you make your final payment and you won’t be charged any unexpected interest.

Compare personal loans

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Name	Product UKFPL	Finder score	Total Payable	Monthly Repayment	Representative APR	Link
Novuna Personal Loan		4.4 ★★★★★				Check eligibility View details Compare	Representative example: Borrow £10,000.00 over 3 years at a rate of 6.9% p.a. (fixed). Representative APR 6.9% and total payable £11,064.60 in monthly repayments of £307.35.	loading Fetching your data...
My Community Bank Personal Loan		4.3 ★★★★★				Check eligibility View details Compare	Representative example: Borrow £5,000 over 48 months at a rate of 24.2% pa (fixed). Representative APR 27.1% and total payable £7,853.87 in monthly repayments of £163.62.	loading Fetching your data...
Fluro (formerly Lending Works) Personal Loan		4.3 ★★★★★				Check eligibility View details Compare	Representative example: Assumed borrowing of £7,500.00 over 48 months at 17.9% APR representative. Monthly cost of £214.79. Total amount repayable of £10,309.78. Interest rate of 16.6% p.a.(fixed) and total fees of £150.00. Available for loan amounts between £5,000 - £25,000.	loading Fetching your data...
thinkmoney Personal Loan		1.5 ★★★★★				View details Compare	Representative example: If you borrow £29,100 over 12 years, initially on a fixed rate for 5 years at 8.885% and for the remaining 7 years on the Lender's standard variable rate of 9.285%, you would make 60 monthly payments of £375.53 and 84 monthly payments of £380.29.	loading Fetching your data...
Tesco Bank Personal Loan		4.5 ★★★★★				View details Compare	Representative example: Borrow £10,000.00 over 3 years at a rate of 6.5% p.a. (fixed). Representative APR 6.5% and total payable £11,003.04 in monthly repayments of £305.64.	loading Fetching your data...
Zopa Personal Loan		4.0 ★★★★★				View details Compare	Representative example: Borrow £1,500.00 over 3 years at a rate of 22.9% p.a. (fixed). Representative APR 22.9% and total payable £2,028.60 in monthly repayments of £56.35.	loading Fetching your data...
Barclays Existing Current Account Loan		4.4 ★★★★★				View details Compare	Representative example: Borrow £10,000.00 over 3 years at a rate of 6.5% p.a. (fixed). Representative APR 6.5% and total payable £11,003.04 in monthly repayments of £305.64.	loading Fetching your data...
Lloyds Bank Existing Customer Personal Loan		4.3 ★★★★★				View details Compare	Representative example: Borrow £10,000.00 over 3 years at a rate of 0.0% p.a. (fixed). Representative APR 0.0% and total payable £0.00 in monthly repayments of £0.00.	loading Fetching your data...
Plend personal loan		3.5 ★★★★★				View details Compare	Representative example: Borrow £8,000 over 48 months at a rate of 16.66% p.a. (fixed). Representative APR 17.99% and total payable £11,013.12 in monthly repayments of £229.44.	loading Fetching your data...
Lendwise		3.5 ★★★★★				View details Compare	Representative APR 10% (fixed).	loading Fetching your data...
Tesco Bank Clubcard Personal Loan		4.5 ★★★★★				View details Compare	Representative example: Borrow £10,000.00 over 3 years at a rate of 6.1% p.a. (fixed). Representative APR 6.1% and total payable £10,941.12 in monthly repayments of £303.92.	loading Fetching your data...

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Questions we’ve been asked about how personal loans work

• Do I have to pay the set-up fee before I receive the loan?

  If a set-up fee is charged with the personal loan you’re applying for, it can normally be added to your loan amount and will then be paid off with your monthly repayments.

• Are there any hidden fees or charges?

  There may be a set-up fee, annual fee or early settlement fee. Importantly remember that “no fee for early repayment” does not necessarily mean that repaying early will save you money in interest. You should check the terms of the loan agreement closely, and if there is any wording you’re unsure of it’s important that you ask your lender.

• What does 'Draw down' mean?

  This is simply a term to describe when the loan funds are actually made available to you by your bank.

• What is the difference between variable and fixed rate loans?

  When you take out a variable rate loan the interest rate you are charged may change over the term of your loan. A fixed rate loan will have an interest rate that doesn’t change, meaning your repayment amounts won’t change either. Generally, unsecured personal loans in the UK use a fixed rate.

• Which is better – a fixed or variable rate?

  This will be entirely dependant on your financial situation, goals and needs. It will also depend on what the future holds – in terms of rates going up or down, and when, which is obviously an unknown. If you want stability and the peace of mind from knowing your repayments won’t change over the life of the loan, then a fixed rate could be for you.

• How do I make my loan repayments on time?

  The easiest way will be to set up a direct debit on or just after your payday each month. Lenders may insist on this.

• I can't make my repayments this period – what can I do?

  If you are struggling to make a repayment, you should immediately contact your bank or lender. They may defer a payment for a month or work with you on a solution. It’s important to note you may be charged extra interest to do this. Some personal loans incorporate an optional “repayment holiday” facility.

• I want to repay my loan in full. Can I do this?

  This is normally possible. Contact your lender to request an early settlement figure. There may be a charge to do this, and in some cases it will save you less in interest than you might anticipate, as lenders may charge up to two months’ interest on sums repaid early.

Written by

Chris Lilly

Head of publishing

Chris Lilly is Head of publishing at finder.com. He's a specialist in personal finance, from day-to-day banking to investing to borrowing, and is passionate about helping UK consumers make informed decisions about their money. In his spare time Chris likes forcing his kids to exercise more. See full bio

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Chris has written 609 Finder guides across topics including:

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