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How to pay off a loan
Before applying for a loan, it’s important to ensure you can afford to repay the amount you want to borrow. Find out more in our guide.
Taking out a loan is not a decision to be made lightly, and you’ll need to have a plan in place for how you’ll repay it. Here, we explain the steps to take to help you pay back your loan in full and on time.
What should I consider before taking out a loan?
When comparing loan options, you’ll need to consider the amount of money that you can realistically afford to borrow. In other words, don't automatically accept the maximum loan amount offered if you can’t afford to repay it.
Loan repayments are usually broken down into fixed monthly instalments. The amount you repay each month will depend on the amount you’ve borrowed, the length of the term and the interest rate charged. It’s crucial that you can keep up with these repayments each and every month as payments are not flexible, as they would be with a credit card.
Using a loan repayment calculator can help you work out how much you’ll be asked to repay each month for your chosen loan. For example, if you wanted to borrow £7,500 over 5 years at an interest rate of 3.7% APR, you’d need to pay back £714 a month.
Will I be eligible for a loan?
As well as considering how much you can afford to borrow, you’ll also need to factor in how much you’ll be eligible to borrow.
As a general rule, you’ll need an excellent credit score to get offered larger borrowing amounts at the most competitive interest rates. If your credit score is low, you might not get accepted for a loan at all. Or you might be offered a smaller borrowing amount at a higher rate of interest.
Choosing a “secured” loan, where you use an asset such as your home or car as collateral, can increase your chances of getting accepted for a loan and borrowing a larger amount. That’s because secured loans are less risky for lenders as they can recover the asset if you are unable to repay your loan. This also means interest rates are generally lower compared to unsecured personal loans.
Secured loans can also be borrowed over a longer time frame compared to unsecured loans, resulting in cheaper monthly repayments. That said, you will be paying money on the debt for longer, meaning the overall cost could be higher - check the total amount payable on the representative example of the loan to see if it will work out cheaper or not.
Secured loans can also sometimes have variable interest rates that mean your repayments could increase unexpectedly.
More importantly, if you don’t pay back your loan on time, you’re at risk of losing your home or other asset. Learn more about secured and unsecured loans in our guide.
Can I get a loan with bad credit?
Getting a loan with bad credit can be more of a challenge, but there are still options open to you. Lenders will consider other factors along with your credit score, such as your income, how much debt you already have and whether you’re in a stable job.
If a lender accepts your loan application, bear in mind you might still be offered a lower borrowing amount, and you’re likely to be charged a higher rate of interest. This means it’s crucial to check you can afford the monthly repayments before proceeding. You might pay around 49% APR with a bad credit loan, for example, compared to the 3% you might be offered with a standard personal loan.
Taking out a secured loan rather than a personal loan can enable you to borrow more. But remember that the loan will be secured against an asset which you risk losing if you are unable to repay the loan.
How to repay your loan
If you’ve decided to apply for a loan, there are several steps you can take to ensure that you repay your loan within the set term.
1. Create a budget
Firstly, you’ll need to draw up a budget that factors in your fixed loan repayments. Have your bank statements to hand when you do this as you’ll need to look at exactly how much you earn, including any benefits you receive, as well as your outgoings.
Your outgoings should include all your debts, including your new loan repayments, bills such as energy, broadband and your mobile phone contract, car and home insurance costs, as well as social and one-off spending such as eating out, birthdays and Christmas.
Stick to this budget if you want to be sure you’ll pay off your loan within the set term.
2. Reduce your outgoings
When looking through your bank statements and outgoings, it’s worth checking whether there’s anywhere you can cut back. You might, for example, discover a magazine subscription or gym membership you’re paying for that you no longer need.
Alternatively, you might be able to shop around for a more competitive broadband deal or a cheaper car insurance policy if yours is up for renewal. Reducing your outgoings and making cutbacks will free up funds to help repay your loan.
3. Boost your income
If, once you’ve drawn up your budget, you’re still concerned about being able to keep up with your loan repayments, you might want to think about ways to boost your income.
This could be through getting a second job, selling unwanted belongings, or even renting out a spare room in your home through the government’s Rent a Room scheme. If you live near a train station, hospital or similar, you might also be able to rent your driveway out.
4. Use your savings
Finally, if you have a decent savings cushion in place, remember you can fall back on this if times get tough. Interest rates on savings accounts are currently lower than they are on borrowing, making it more cost-effective to use your savings to clear your debt.
What happens if I miss a loan repayment?
If you miss a loan repayment you’ll usually be charged a fee of around £25. The exact amount will depend on the type of loan you have, how much you’ve borrowed and your provider.
On top of this, a missed payment will usually be reported to credit reference agencies and noted on your credit file. This can make it harder to get accepted for credit in the future as other lenders will be able to see that you’ve missed payments in the past.
If you only miss one payment, no further action should be taken. But remember that even one missed payment can result in you paying more interest on your loan overall and take you longer to repay it.
What happens if I default on the loan?
If you continue to miss loan repayments, the consequences can be more serious. Missing payments or failing to repay the full amount required each month for three to six months is known as defaulting.
If you default on your loan, you’ll receive a formal letter called a default notice from your lender. This will set out the details of your loan, what terms you’ve broken and what steps you’re ou need to take. A default notice will also be added to your credit report which can make it harder to borrow in the future.
If you’re still struggling to repay your loan, your debt could be sold to a debt collection agency which will then seek to recoup its money, plus a profit, from you. Read more in our guide: What happens if you are unable to pay back your loan?
What should I do if I can’t pay off my debt?
If there is no way for you to pay off your loan, you might have to use an Individual Voluntary Arrangement (IVA). This is a formal and legally binding agreement between you and your creditor to pay back your debt over an agreed period. Failing that, you may have to declare yourself bankrupt which can have a huge impact on your credit record.
But before you get to that point, it’s best to be as honest as possible with your lender. The minute you think you might miss a repayment, get in touch with your lender to explain your situation. They should work with you to assess how you can pay back your debt in a more manageable way before any further action needs to be taken.
For example, they might agree to:
Lower the amount of interest you have to pay
Give you longer to repay your debt
Reduce your monthly repayments
Delay reporting the missed payment to credit reference agencies
Offer you a payment holiday (although interest might well continue to be built up)
It’s also well worth seeking help from debt charities as these can offer free advice and support and help you get your finances back on track. Free services to try include:
Frequently asked questions
No deposit mortgages FAQs
Will taking out a loan affect my credit rating?
Any form of borrowing will impact your credit rating. However, providing you make your loan repayments on time each month and repay the full loan amount within the set term, it should have a positive effect on your credit score. If your credit score goes up, this increases the chances of you being offered a better deal the next time you apply for credit.
Can I pay off my loan early?
Yes, you can usually pay off your loan early if you choose to. However, you might have to pay an early repayment charge of around one to two months’ interest. This should be outlined in your loan agreement.
If you took out an unsecured loan from February 2011 onwards, you can make partial or full early settlements of up to £8,000 a year without paying a penalty fee. Once more than £8,000 has been repaid, if you have more than a year left on your loan agreement, you can be charged a penalty fee of up to 1%. If there is a year or less left on your loan agreement, the penalty is capped at 0.5%.
What are the alternatives to a loan?
Yes, you can usually pay off your loan early if you choose to. However, you might have to pay an early repayment charge of around one to two months’ interest. This should be outlined in your loan agreement.
If you took out an unsecured loan from February 2011 onwards, you can make partial or full early settlements of up to £8,000 a year without paying a penalty fee. Once more than £8,000 has been repaid, if you have more than a year left on your loan agreement, you can be charged a penalty fee of up to 1%. If there is a year or less left on your loan agreement, the penalty is capped at 0.5%.
Can I change my mind about a loan?
If you want to cancel your loan, you’ll have a 14-day cooling off period from either the date the loan agreement was signed or when you received a copy of the agreement, whichever is later. If the funds have already been transferred to your bank account, you’ll need to repay the money within 30 days.
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