What types of credit can you get?
There are many different types of credit available and it is important to understand the finer details before you borrow. The ability to understand which form of loan or credit facility is best for your individual situation is a key part of getting the best deal and helping to improve your financial wellbeing. Below, we give an overview of the different types of credit available and for which situations they might be appropriate.
Certain credit is available on an ongoing basis, where the level of debt is flexible and can be paid down or raised depending on the needs of the borrower. An agreed overdraft is an example of this type of credit and is used in conjunction with a current account. There are various reasons an overdraft may be useful, for example, if an individual’s cash flow is unpredictable because they are self-employed. In this instance they may need the ability to temporarily go into debt at short notice, until they can collect or process payments.
Overdrafts can also be useful in cases of unexpected bills or charges made in error. Without an agreed overdraft, these unplanned withdrawals could cause the borrower to become unintentionally overdrawn and incur additional fees.
Another example of a credit facility that is flexible up to a certain limit is a credit card. Credit cards are issued at an agreed rate of interest and with a specific spending limit. Debts can be accrued or paid off at any time.
For example, if your credit card has a limit of £1,000, and you spend £300 in a month, you will have £700 left available to you. When you make a payment, either the minimum required or more, the same amount becomes available to borrow. Any money you haven’t paid back is added to your owed balance where it may gather interest. However, if you don’t make the minimum payment, this will be recorded in your credit history and over time your credit limit could fall or the interest rates you have to pay could rise.
There’s a huge variety in the types of loan you can get, from personal to business, secured to unsecured (see below) and short term to fixed rate long term loans. In these cases, a fixed amount of money is agreed by a lender and paid back by the borrower over a fixed period of time. E.g. a £5000 loan could be paid back in instalments, with interest, over a period of two years.
The interest rate can be fixed or variable, if it is variable it can go up and down and may be linked to an index like the Bank of England base rate. A fixed rate will be consistent for the period of repayment.
Short term loans are similar to longer term loans in terms of making regular repayments and having fixed or variable interest rates. However, they will typically have a higher interest rate and will normally be used by people who need access to credit very quickly. One form of short term loan is a 'payday loan' which may only last for a matter of days and as such can come with a very high APR (Annual Percentage Rate).
If credit is secured it means that it is tied to one of your possessions, which acts as security. Failure to make your repayments on time could lead to the security being repossessed by the lender as compensation for the debt. Mortgages and car loans are examples of secured loans – if you miss too many payments on these credit agreements, the lender could reclaim your house or car.
Pawnbrokers are another example of secured lending and tend to use smaller value items like jewellery or electronics as security for their loans. There also exists a category of high-end asset lenders, who loan against items like artwork, antiques, luxury cars and even designer handbags.
An unsecured line of credit involves no asset to act as security – the terms of the agreement are based on your credit history and personal information given on your application. If you miss repayments, it could negatively impact your credit report, which may make it more difficult to get loans in future.
Some unsecured loans may have a higher interest rate or lower borrowing limits when compared to secured loans, because of the lack of security. This will depend on the individual borrower and their credit history, as well as the particular lender. You can read more information these types of credit in our secured vs unsecured loans article.
Unsecured loans will require a credit check that uses your credit history to determine how likely you are to repay your loan. Various information is included in your credit history, which you can read about in our What is a Credit Report? article.
You can also review your Equifax Credit Report & Score, which is free for 30 days and then £7.95 a month, to learn more about your credit history.
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