How do loans work? What you need to know

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How do loans work?

Before taking out a loan, there’s a lot to think about. Which lender offers the best interest rate? Can you get access to their best rate? Are there options available other than borrowing? Will you be able to meet the monthly repayments? It can all seem a bit overwhelming.

So, how do loans work? The more you know, the better equipped you’ll be to make the right decision.

In this guide, we’ll cover everything you need to know. If you’ve got questions at the end, please contact us. You can speak to one of our team on our handy website live chat feature between 9am-6pm on a weekday.

How do loans work and is taking one out a good idea?

Before taking out a loan, it’s important to do your research to make sure that you’re getting a good deal. Rushing into a loan without finding out average interest rates or knowing whether there will be early repayment fees could mean you get a bad deal. Always search the market to find loans which are affordable and suit your needs.

If you take out a personal loan, it could have a positive impact on your credit score - making it easier to borrow money and secure better interest rates in the future. However, you should only take on a loan if you can meet the repayments. Failure to repay your debt will affect your credit score negatively and make it harder to borrow money later. If you’re worried about affecting your credit score, use a lender that uses Open Banking like us at Salad Money. Open Banking means we don’t need your credit score, and any loan you take with us won’t affect it either.

Ask yourself whether borrowing money will make your life easier or harder. If you already owe money on a credit card, another loan, or mortgage, is taking on more debt a good idea? Alternatively, you could dip into savings, get a part-time job, or live below your means until your finances are back on track.

What to look for when considering a loan

Secured vs. unsecured loans
So, how do loans work when they’re secured compared to unsecured? If you take out a secured loan, your provider will ask you to guarantee an asset. This could be your home or car and gives the lender peace of mind - because they’ll be able to recoup their losses if you can’t pay them back. Unsecured loans are usually offered to people with lower credit scores, or people who don’t have an asset who want to borrow money. With an unsecured loan, no such guarantee is needed.

The application for secured and unsecured loans is as follows:
Apply for your loan and tell your lender how much you want to borrow and for how long.
If your application is successful, your provider will offer your loan at a specific rate.
If you accept the terms, the money will normally hit your account within 24 hours.

Interest and fees

When you take out a loan, you’ll pay interest on the full amount. Payments are made monthly and split into two parts - one that pays off the debt; another that pays off the interest. Each lender is different, so check how your payments will be structured before proceeding. Also, be aware that interest rates are often higher during the first few months - especially if you’re taking out a large loan like a mortgage.

How do loans work in relation to fees and other charges? If you borrow money, APR (which stands for ‘annual percentage rate’) is usually added. APR incorporates the interest on your loan and other fees applied by your provider - such as early repayment penalties. It’s important to compare APR rates across different lenders if you want to get a competitive interest rate and pay less.

If you take out a loan with Salad Money, there are no hidden fees or early repayment penalties. We make sure all the information is clear and easy to understand, so you’ll know exactly how much you’ll need to pay off, and by when, before you take out a loan with us.

The term of your loan

The term of your loan is the number of months you have to clear your debt. Once your application has been approved by your provider, they’ll confirm the interest rate and length of your loan. At this point, you can either accept or decline.

How do loan repayments work?

But how do loans work in terms of repayments? Your lender will set out a schedule in your agreement that illustrates
(i) what you’ll be expected to repay each month; (ii) the duration of the agreement. With each successful instalment, you’ll pay off some of the interest and the debt.

In an ideal world, it’s best to clear a debt quickly. Most lenders allow overpayments which means you’ll be able to enjoy peace of mind sooner and pay less overall - because interest is usually calculated on the total sum owed (or principal).

Things to consider when completing your loan application

For traditional lenders, your credit score will influence whether your application is successful and, if so, the interest rate payable. If you don’t know what your score is, it’s a good idea to find out before applying to lenders so you can (i) manage your expectations; and (ii) challenge the result if you think it’s wrong.

If you have a bad credit score, or no credit score at all, then use a modern lender that uses Open Banking like Salad Money.

Just as importantly, how do loans work from a lender’s point of view? What criteria are they using to approve or deny your application?

Here are three criteria used by loan providers:

Your salary and career track record. If you’re a high-earner with a strong employment record, lenders are more likely to review your application favourably. From their perspective, you’ll have the means to repay your loan - and, statistically, be less likely to lose your job.

Your debt in relation to your income. If you earn a lot and have a stable job, but have other debts, you might struggle to meet your loan repayments, so expect your lender to take this into account when reviewing.

Whether you have any assets. Lenders often ask applicants to provide something of high value - like a car or a home - as a guarantee for an unsecured loan. Owning valuable assets like this will work in your favour.

At Salad Money, we offer an innovative Open Banking service that’s secure, FCA-regulated and allows us to assess applications without harming your credit score.We also don’t require any assets. You will need to have been employed by the NHS for a minimum of three months, but if that applies to you, apply online now or contact us to learn more.

Glossary of terms

APR. This stands for ‘annual percentage rate.’ It incorporates the rate of interest you’ll pay and any other fees your provider has added to the loan.

Compound. More common with savings accounts or credit cards, you’re charged interest not just on the principal but also on the interest itself.

Simple. Interest is multiplied by the amount borrowed, which means you’d pay £2,100 on a £2,000 loan charged at a rate of 5%.

Amortized. In this case, expect to pay more interest initially. Payments stay the same but eventually you’ll be able to pay off more of the debt and reduce the amount of interest chargeable.

Fixed. As its name suggests, the rate of interest remains constant throughout the term of your loan so you can budget more effectively.

Variable. The interest rate will adjust in line with the market, which means your repayments could rise or fall.

How do loans work for NHS employees?

At Salad Money, we’re committed to making it easier for key workers to obtain credit. Unlike some providers, our interest rates are low and we specialise in offering loans that are both small and affordable.

Our loans can be salary deducted if your employer is partnered with us or taken via direct debit.. Using our secure Open Banking service won’t affect your credit score either. This means we can review details of your income and make a more informed decision.

Apply now or get in touch to learn more.

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