How personal loans work

A personal loan is a fixed amount of money borrowed from a bank or another lender, repaid in fixed monthly instalments over an agreed period called the term of the loan¹. Most personal loans are unsecured, which means the loan is not secured against your home². You normally borrow between £1,000 and £25,000, although loans for as much as £50,000 are sometimes available³.

Because the amount, the monthly payment and the term are all fixed at the start, you know from day one what you will pay each month and when the debt will end. That predictability is the main reason people choose a personal loan over a credit card or overdraft for larger purchases. The trade-off is that you commit to repaying the full amount, and missing payments has consequences for your credit record and, in the worst case, for a court judgment against you.

A personal loan is a fixed sum repaid in fixed monthly instalments

When you take out a personal loan, you borrow a fixed amount from a bank or creditor and repay it in fixed amounts over an agreed number of months or years². Citizens Advice describes the same structure: you borrow a fixed amount, repayable by set monthly instalments over an agreed period of time, called the term¹. Loan repayments are usually monthly at a fixed amount⁴.

The fixed instalment is what separates a personal loan from revolving credit. A credit card or an overdraft is a type of loan that often has interest, borrowed through your current account, where the balance can go up and down as you spend and repay⁶. A personal loan is different: the money arrives as one lump sum, and from that point the only thing that changes is how much of the debt is left.

One caveat on the word "fixed". Your loan repayments are usually fixed, but if you are borrowing on a variable interest rate, your repayments may change if the bank's interest rate changes⁷. Some personal loans do have interest rates that vary, and there is a risk that this could become hard to afford, so a fixed rate is generally the safer structure to plan around². The page on fixed vs variable interest rates on loans covers the difference in detail.

A personal loan is also a formal credit agreement. Once you sign, you are committed to repaying the full amount under the terms agreed, and the agreement is regulated by the Consumer Credit Act, which gives you certain rights as a borrower⁸. Those rights, including a 14-day window to withdraw, are covered in your rights under the Consumer Credit Act.

How much you can borrow and for how long: usually £1,000 to £25,000

Unsecured personal loans usually run from £1,000 to £25,000, although loans for as much as £50,000 are sometimes available³. Which? gives the same range, noting that loans for as much as £50,000 are available from some lenders⁹. HSBC, as a lender, states you can usually borrow between £1,000 and £25,000⁴.

The term is the other half of the equation. first direct spreads its personal loan repayments over 1 to 8 years⁴. Other lenders set different ranges: Nationwide offers terms of 1 to 7 years, or up to 10 years if you borrow £10,000 or more¹⁰, TSB lends over 1 to 7 year terms¹¹, and the Post Office over 1 to 5 years¹². So terms between one and eight years exist in the market, with most lenders somewhere in between.

The term matters as much as the amount, because of how interest behaves over time. If you take out a loan over a longer period you may find that the payments seem lower, but you pay interest for the whole time you owe the money, so you end up paying more in total². HSBC makes the same point: the longer you take to pay back your loan, the more interest you will pay⁴. A shorter term means higher monthly payments but a smaller total cost; a longer term means the reverse. The page on how loan interest is calculated explains the mechanics.

For context on the market as a whole, Bank of England statistics divide lending to individuals into lending secured on dwellings (mortgages) and consumer credit, which is itself split into credit card lending and "other" lending, mainly overdrafts and other loans and advances¹³. Personal loans sit in that second category, and the effective rate on new personal loans to individuals stood at 9.14% in July 2024, up 21 basis points over the month⁵.

What a personal loan costs: interest, APR and other charges

The cost of a personal loan is made up of the interest you pay plus any charges. The APR, or annual percentage rate, is the figure designed to let you compare like with like. It takes into account the total cost of borrowing, including the total amount of interest you will pay, any additional charges such as a monthly fee, and when and how often you must pay the interest¹⁴. Because APR bundles the charges in, two loans with the same headline interest rate can cost different amounts if one carries fees and the other does not. The page on loan APR, representative APR and personal APR explains how the advertised figure relates to the rate you are actually offered.

On rates themselves, the lowest rates on personal loans have generally been around 3% to 4%¹⁵, but that reflects the cheapest deals for the strongest credit records, not what everyone pays. The effective rate on new personal loans across the market was 9.14% in July 2024⁵. Rates also move with the wider economy: personal loans became more expensive in the immediate aftermath of the 2008 rate cut, then gradually came down, behaving differently from credit cards and overdrafts¹⁶.

Charges to look for beyond interest include arrangement or administration fees, and any charge for settling early. Not all lenders charge these. Loans from credit unions are generally cheaper than loans from most other providers for smaller amounts and do not incur set-up fees, administration costs or early redemption fees³. The page on loan fees and charges lists the charges to check before signing.

The single most useful number when comparing loans is the total amount repayable: the sum of every monthly payment across the whole term. It captures both the interest rate and the length of the term in one figure, and it is the honest way to compare a cheap long loan against a dearer short one.

Secured or unsecured: what is at risk if you cannot pay

Most personal loans are unsecured, which means the loan is not secured against your home². An unsecured loan is a loan that is not linked to items of value, like your home or car, and these are normally called personal loans¹⁷. Unsecured means the loan is not linked to your home¹⁸.

A secured loan is the opposite arrangement. Secured loans are backed by your property, meaning your home could be repossessed if you are unable to keep up with repayments³. Citizens Advice puts it plainly: the security offered may be at risk if you do not keep up with repayments on a secured loan¹. A secured loan means you can lose your home if you do not keep up the repayments¹⁹.

The distinction matters most when a loan is being used for debt consolidation. A consolidation loan may be an unsecured personal loan, but if you are a homeowner it may be secured against your home¹⁰. If the loan is secured on your house, then it could be repossessed if you do not keep up with the payments¹¹. The same warning applies to loans secured on business assets: your home could be repossessed if you have used it as security and cannot keep up the payments on the agreement²⁰.

Secured lending also reaches people unsecured lending does not. Lenders offering secured loans may lend to people with a bad credit history who would not get an unsecured personal loan²¹. That wider access is the attraction, and the risk of losing the security is the price of it. The comparison page secured or unsecured borrowing compared sets the two side by side.

What people use personal loans for, and where lenders draw the line

Personal loans are used for large one-off costs: home improvements, a car, or paying off other debts. Which? notes that if you do not have enough saved, it might be worth taking out a personal loan for home improvement projects costing under £25,000³. Buy now pay later agreements are themselves a type of personal loan, often used for big items like a new phone or boiler¹².

Debt consolidation is one of the most common uses. You work out how much you need to borrow to pay off all your debt, apply for a loan for that amount, and if approved use the money to pay back each of your creditors, leaving one monthly repayment to the loan lender²². Another way of describing the same process: pay off your creditors with money you borrow, then make monthly payments to pay off the loan instead of your credit cards²³. Building societies and banks may be able to offer you a personal loan for this purpose²⁴. The page on debt consolidation loans covers the trade-offs, and consolidation loan or free debt advice covers when advice is the better route.

Not every use is wise, and some uses signal that borrowing is papering over a problem. Research on UK adults in financially vulnerable circumstances found many people in this group using personal loans to cover rent or mortgage payments, alongside taking out high-cost payday loans²⁵. Using borrowed money to cover housing costs is a warning sign rather than a plan, and free debt advice is the better response. Personal loans, payday loans and short-term loans are all examples of consumer credit debt²⁶, and credit debts like bank loans, credit cards and overdrafts are usually a lower priority than debts such as council tax because they cannot be enforced by evicting you from your home, sending you to prison or disconnecting an essential service²⁷. The page on what to do if you can't repay a loan picks this up.

Lenders also draw lines in their terms. A loan agreement is for a stated amount and purpose, and while unsecured personal loans are generally flexible, some lenders restrict what the money can be used for. Check the terms before you apply rather than after the money arrives.

Who can get a personal loan and how lenders decide

Each finance provider has its own eligibility and assessment criteria and makes its own lending decisions²⁸. There is no shared rulebook for who gets a loan: what one lender refuses, another may accept. Lenders in other markets work the same way; it is up to mortgage lenders, for example, to set their own policies about whether they will accept an application²⁹.

The two things every lender weighs are your credit history and affordability. A poor credit rating narrows the options: you may only be able to get a loan at a high interest rate, or secured against your home²⁴. Each finance provider sets its own eligibility and assessment criteria and makes its own lending decisions²⁸, so being turned down by one lender does not mean every lender will reach the same answer. The page on getting a loan with a poor credit history covers the realistic options, and near-prime and subprime lenders explained covers the lenders that specialise in this part of the market.

There are rules on how lenders must behave when you apply. There is a duty for lenders to provide adequate explanations to consumers about the credit on offer, to enable them to decide whether it is suited to their needs and circumstances; in face-to-face situations certain explanations must be given orally³⁰. That duty sits alongside the affordability checks lenders must run before lending, covered in loan affordability checks: what lenders must check.

For people with limited options from mainstream lenders, responsible finance providers offer fair and affordable credit for people and households, including people who may have limited options from mainstream lenders²⁸. Credit unions are part of that picture: some offer current accounts, usually with no credit check or overdraft³¹, and you usually will not have to pass a credit check even if you apply for an overdraft, because credit unions normally use manual checks to decide whether to lend³². The pages on credit union loans and community lenders (CDFIs) and affordable credit set out these alternatives.

How applying, approval and payout work

You can apply for a loan in person at a branch or by post, phone or online¹. The application asks for the amount and the term, which together set the monthly payment and the total cost. The lender then checks your credit history and assesses affordability, and if it is willing to lend, it must explain the credit on offer so you can decide whether it suits your needs³⁰. Once you sign the agreement, the money is paid as a lump sum straight into your account³³.

Two points in that process deserve attention. The first is the explanation stage: the duty on lenders to provide adequate explanations exists so that you can judge whether the loan suits your circumstances, and in a face-to-face sale certain of those explanations must be given orally³⁰. The second is the agreement itself. When you have taken out a loan you have to repay the full amount³⁴; signing is not a provisional step. You do, however, have a 14-day right to withdraw after signing, covered in the 14-day right to withdraw from a loan or finance agreement.

If you are applying through a broker rather than directly with a lender, the broker's fees and how they feed into the APR are covered in direct lenders and loan brokers: what is the difference? and credit broker fees and the APR. The general process, whatever route you take, is set out in how to apply for a loan.

Using a personal loan to buy a car

When you buy a car with an unsecured personal loan, you own it³⁴. That single fact drives every other difference between a personal loan and car finance. You can sell the car at any time³⁴, because it is yours and not the lender's. The loan provider cannot take the car back if you miss payments³⁴, because the loan was never secured on the car in the first place.

The other side of that coin is that the loan does not end when the car does. When you have taken out a car loan you have to repay the full amount³⁴, whether the car is still running, written off, or sold on. You also have no rights to end the agreement and return the car early³⁴, because there is no agreement with a car attached to it: there is just a loan.

Contrast that with the alternatives. Hire purchase and personal contract purchase agreements tie the car to the credit: the finance company owns the car until the final payment, and it can repossess if you default. Logbook loans sit at the risky end of secured lending: they are a way to borrow money using your vehicle as security⁸, and while you can use them to buy a car, they are often used to borrow cash secured against a car you already own³⁴. The comparison page logbook loan or unsecured personal loan sets the two side by side, and car finance or a personal loan for buying a car? weighs the whole question. The wider market is covered in how car finance works.

Repaying early, extending the term or taking a repayment holiday

In some cases, you can make overpayments or repay the loan in full before the end of the agreement without penalty⁴. Whether that applies to a particular loan depends on its terms, so check the agreement before assuming. Where an early settlement charge does apply, it is worked out from the outstanding balance and the remaining term; the page on paying off a loan early and settlement figures explains how the figure is calculated.

Credit union loans are a clear case on charges: they do not incur set-up fees, administration costs or early redemption fees³. That makes early repayment straightforwardly worthwhile where the loan allows it, since settling early cuts the interest still to run.

Extending the term works the other way. Stretching a loan over a longer period lowers the monthly payments but raises the total cost, because you pay interest for the whole time you owe the money². Some lenders offer payment holidays, a temporary pause on repayments; these are covered in payment holidays on loans and credit cards, including the fact that interest usually keeps building during the pause, which is why a holiday costs money rather than saving it.

Topping up an existing loan, borrowing more on top of what you already owe, is a separate decision with its own costs, covered in topping up an existing loan.

What happens if you miss repayments

If you miss repayments or default on your loan, you may be charged interest on the overdue amount plus any administration fees from the lender, and it could also impact your credit score and your ability to borrow in the future⁴. If you do not take steps to deal with the debt, the loan will default, usually after two or three missed payments².

After a default, the lender can pursue court action. Payday lenders, for example, can raise a county court judgment (CCJ) or decree against you if you do not repay what you owe³⁶, and the same route is open to personal loan lenders. In Scotland the equivalent court order is a decree rather than a CCJ³⁶.

If you miss payments on a credit union loan, the credit union may be able to use your savings to repay the loan²⁰. That is a power credit unions have that banks do not, and it is worth knowing if your savings and borrowing sit with the same credit union.

The most important practical point is that missing payments does not have to run its course. Lenders will typically contact you after you miss one or two payments and should discuss ways for you to catch up with payments and pay the arrears³⁴. Free debt advice, from charities such as StepChange and National Debtline, is available before things reach a default, and the page on what to do if you can't repay a loan sets out the steps in order.

Personal loans compared with overdrafts and credit cards

An overdraft is a type of loan that often has interest, borrowed through your current account⁶. It suits small, short gaps between money coming in and going out. For anything larger or longer, the cost structures diverge. Certain types of borrowing, such as overdrafts, revolving credit on your credit card and payday loans, also charge higher interest than a typical personal loan³⁷. That is the core reason a fixed-sum loan with fixed monthly repayments is usually the cheaper structure for a planned purchase spread over a year or more.

The Bank of England makes the same distinction in its statistics: consumer credit is split into credit card lending and "other" lending, mainly overdrafts and other loans and advances¹³. The two halves behave differently, and so do their costs.

Overdraft debt can be escaped by refinancing: one route is to repay the balance using credit with a lower interest rate, such as a balance transfer to a credit card or an affordable loan³⁸. Banks themselves may propose this: if you are worse off after overdraft changes, your bank might reduce or waive interest, offer a continuation of overdraft borrowing at the current rate of interest, or agree a repayment programme possibly including a personal loan⁶. The comparison page arranged overdraft or small short-term borrowing weighs the options for small amounts.

For very short-term gaps, payday loans are the expensive end of the market, and free alternatives exist: budgeting loans, for help with essential one-off large payments that are difficult to plan for, such as a broken boiler, are one option³⁹, covered in Budgeting Loans and Budgeting Advances. The pages on cheaper alternatives to a payday loan and payday lending and high-cost short-term credit cover that market and its cost cap.

What protects you when you take out a personal loan

Personal loan agreements are regulated by the Consumer Credit Act⁸, which is the foundation of most of the protections that follow. The page your rights under the Consumer Credit Act covers them in full.

The protections that matter most in practice:

• Adequate explanations. Lenders have a duty to provide adequate explanations about the credit on offer, to enable you to decide whether it is suited to your needs and circumstances, with certain explanations given orally in face-to-face situations³⁰.
• Affordability checks. Lenders must check that the loan is affordable before lending, covered in loan affordability checks.
• The right to withdraw. You have a 14-day window to withdraw after signing, covered in the 14-day right to withdraw.
• Early settlement rights. In some cases you can make overpayments or repay the loan in full before the end of the agreement without penalty⁴, and the rules on settlement figures are covered in paying off a loan early.
• Complaints. If a lender treats you unfairly, you can complain to the lender and then to the Financial Ombudsman Service, covered in complaining about a lender or finance company and complaining about an unaffordable loan.

Where protection stops is just as important. An unsecured loan cannot take your home directly, but a lender can still pursue you through the courts, and a CCJ or decree can follow³⁶. A secured loan can end in repossession of whatever is secured¹⁹. And if you are struggling, the priority order of debts matters: credit debts are usually a lower priority than debts that can be enforced by eviction, imprisonment or disconnection²⁷, which is why free debt advice, available from StepChange, National Debtline and Citizens Advice, is worth taking before a default rather than after one.