The world of personal finance is full of different terms for different types of credit, many of which sound the same or refer to products that aren’t described very well by their names. We love to help customers by de-mystifying these words to help you make better choices, and today we’re going to be tackling small loans. Sounds simple, right? Well, it can be, but there are a few things you should understand about small loans before you apply for one. So let’s take a look.

What Is a Small Loan?

To a certain extent, a small loan is exactly what it says on the tin: A loan of a small amount of money, typically between £100 and £500 but always less than £1000. However, it’s also a loan that isn’t secured against any real-life collateral such as a car, a house or furniture. This means that small loans tend to be easier to get and highly flexible but are viewed less favourably by credit agencies than secured loans against objects.

What Is a Small Loan For?

Typically, people take out small loans to pay for emergency purchases or to bridge small gaps in their finances that savings can’t plug. If you suddenly find yourself a hundred pounds short of being able to cover your water bill, if your boiler breaks down and you need money to get it fixed or if your car blows a tyre and you can’t afford a new one, small loans are there to help you out. The flip side of this is that the repayment times are often just as short, typically measured as one to six months, meaning that the interest rate on the loan can be much higher than would be expected if borrowing a larger amount over a longer time or against the value of an object.

How Should I Use a Small Loan?

While small loans can be convenient for unexpected expenses, they aren’t designed to be used for regularly tiding your expenses over or for treats such as clothes, entertainment and holidays. The high interest rate makes such loans expensive if used regularly, which can quickly allow them to build up into problem debt rather than a temporary safeguard. However, they can be perfect when used to borrow small amounts that don’t attract affordable levels of interest in situations where other loan forms aren’t appropriate.

Advantages of a Small Loan

With that said, let’s take a look at the advantages of taking on a small loan. For one thing, they’re often possible without stringent credit checks. While no loan is free of credit checks, it’s the law that creditors have to do at least a basic check, and it is often possible to get a small loan with only a soft check. Because the loan is for a comparatively small amount, you’re more likely to pass the check, and so there’s a good chance that you’ll be approved, removing one of the biggest barriers to finance. It also means that bad credit is often not too much of a barrier to getting a small loan, which can be an invaluable lifeline to many people in need of finance and struggling for cash.

Another advantage of small loans is that you can often gain finance much faster than using traditional methods. Borrowing larger amounts of money can take a long time, often between three and ten days, because of the number of checks and approvals that such loans have to go through with lenders. While you may get your money eventually, that’s often too long for a genuine emergency like a broken boiler that leaves you without hot water. Because of the less stringent credit check, small loans can be processed and in your pocket much more quickly than a secured or larger loan. Unlike banks, many companies offering small loans are also set up to facilitate fast finance so that they can help you 24/7 all year round. No holiday or weekend closures.

A third advantage of using small loans is their flexibility. Whatever your situation, whether you’re employed on a part-time basis or a zero-hours contract, it is possible to access finance in the form of small loans, which may be denied to people who try to borrow more. Small loans providers are also much less prescriptive regarding how much you need to borrow, with many traditional lenders specifying minimum amounts that are much larger than the amount you would actually need but that you would have to pay for. Generally, as long as you meet the minimum income threshold, small loans lenders are much less concerned with making you jump through hoops to access finance.

Are There Any Disadvantages?

As we indicated earlier, these types of loans are designed to provide you with small amounts of money in emergencies. They aren’t meant to be used regularly to bridge larger gaps or to make non-essential purchases. The high interest rates these loans attract make them unsuitable for long term use and can lead to problem debt. If you find yourself in financial difficulty as a result of taking out one of these loans, or if you find yourself relying on them regularly to plug financial gaps, it can be a good idea to get in touch with a debt charity such as Step Change who can help you break the cycle.

What Kinds of Small Loans Can I Get?

There are several different types of small loans that are useful in different situations. They differ in everything from how much you can get to the method that you use to pay them back and the interest rate you’ll pay. Not every type of small loan is right for every borrower, so it’s important to make sure you’ve made a good selection. Let’s take a look at what types of loans are available.

Payday Loans

Payday loans are probably the most well-known type of small loan, having received a lot of press attention and having exploded in popularity over the last decade. This type of loan originated because it was originally designed to tide a person over until their next payday if there is any shortfall in the amount of money they needed. As such, it was designed to be taken out in one month and paid back at the same time the next month, plus interest. As a result, the big difference here is that there are no instalments, and the entire loan is paid back in one go, so there’s only one lump sum of interest and not several interest payments.

While payday loans have gained a reputation for being expensive, in fact, there is a cap of 0.8% worth of interest on the total loan amount per day of the loan, and the total amount of fees and interest can’t exceed 100% of the original loan’s value. That means many of the horror stories you may have heard are no longer true, and payday loans actually are affordable. All of this together means that payday loans are a very transparent and upfront method of borrowing money, with all the costs made clear upfront, and can’t cost you any more if you pay on time. This is attractive for borrowers looking for a quick fix.

Small Personal Loans

In contrast to payday loans, small personal loans are much more like traditional borrowing that you might have done with a high street bank. This has good and bad elements to it, however. For one thing, personal loans don’t come with the requirement to pay them back in a month, so they tend to cost less, and you have more time to pay them back. However, you don’t get the positive elements of payday loans using this method, so there aren’t the same caps on interest rates or total borrowing costs that you’d find in payday loans. This means it’s possible to find yourself paying back more money, even though it’s over a longer period, especially if you miss instalments or the interest rates change.

Line of Credit Loans

We’ve already stated that small loans aren’t a good option for people who need to borrow frequently or need to borrow large amounts, but there is a type of small loan that is more suited to this purpose called a line of credit loan. Rather like a credit card, line of credit loans allows you to borrow up to a credit limit and borrow it all over again once you have paid back the first amount with interest. If you’re likely to need regular injections of credit like this, it can be a good option because it doesn’t involve getting a credit check and going through the rigmarole of getting your loan sorted every time. It also means you can get access to the cash even faster than you would be able to with a payday loan because it’s immediate, and you can spend as much or as little as you need to without making separate applications for credit. It’s also a decent option for people who don’t have good enough credit to access a credit card, though the interest rates are higher for the money you borrow.

While the similarities between line of credit loans and credit cards or overdrafts are striking, it’s important to remember that it’s not the same. In overdraft and credit card agreements, the borrowing of the money is free minus any money that’s leftover in arrears at the end of the month, which attracts interest. By contrast, every bit of spending on the line of credit agreement is seen as a separate loan that attracts interest, so it’s not cost-effective to treat it like you would a credit card.

Other Types of Small Loans

While these are the main types of small loans, lenders will often offer many types of traditional loans in small loan form, including debt consolidation loans and loans with special conditions like fast pay and same day loans. These operate in much the same way as their traditional equivalents, but you should always make sure you check the terms and conditions so you can be sure it is right and affordable for you.

Will a Small Loan Impact My Credit Score?

Many small loan providers claim to offer ‘invisible’ loans that don’t impact your credit score or don’t involve credit checks. That’s not true, but it’s also not true that they make you untouchable to banks. It’s a legal requirement for lenders to make sure that the type of loan that you are going for is affordable, even if it’s just a soft credit check that won’t make a big impact on your score. Still, generally, the amounts are small enough that people with good credit won’t have trouble borrowing. As long as you are diligent about keeping up your payments and don’t miss any, you should be in no worse position than if you took out a traditional loan. Miss payments, however, and there will definitely be an impact.

What Fees Are Included?

As with traditional loans, small loans are also subject to fees on top of the interest rate you’ll pay. Not all lenders charge all fees, and the fees you’ll pay should be a factor in deciding who to borrow from, but the following fees are commonly charged on loan amounts:

– Broker fees: These are the fees that finance brokers charge for the service of linking you up with an appropriate lender.
– Transfer fees: Some lenders charge you to move money around, which can mean charging you to transfer money to your account as well as charging you to make payments. This can be a big factor if you plan to borrow regularly.
– Late payment fees: Some lenders add additional fees on top of interest if you pay late.
– Fast payment fees: Some loans are designed to be paid into your account faster, which can incur an extra charge.

Small loans aren’t for everyone, but for people who need a small cash injection to tide them over to the next payday or invest in something that will change their lives, they can be a ticket to financial freedom. Free from the strict constraints of a high street bank or traditional lender and able to pick and choose just about every condition of the loan, people who use small loans can flourish and grow even if their credit history isn’t stellar, opening up a world of finance many people will have given up on long ago.