Eric:'Peter, you know a lot about loans. I'm looking for a personal loan at the moment to build a swimming pool and don't want to make any mistakes.'
Peter:'No problem. Are you looking to get a secured loan where the loan is guaranteed by your property, or an unsecured loan where it's not connected to your property?'
Eric:'I'd prefer to not go for a secured loan. I don't want the bank to take my house if can't pay the loan back. I'd prefer an unsecured loan.'
Peter:'An unsecured loan is less risky for you, because there's no possibility of losing your property. But because it's more risky for the lender or bank, the interest rate is higher. So it's more expensive, you'll pay a higher interest rate on the loan. How much do you want the principal of the loan to be?'
Eric:'What does the principal of the loan mean?'
Peter:'The principal means the amount of money you want to borrow.'
Eric:'The principal will be £15,000. I'd like a repayment period of four years, so I will have paid all the money back to the bank in that time. Also, is the interest rate the same as the Annual Percentage Rate?'
Peter:'More or less yes. The Annual Percentage Rate or APR does show how much interest you pay on the loan each year that you have the loan. But the APR also includes fees or additional costs that the bank charges you for obtaining the loan, like loan processing or administration fees. So, if the bank charges a yearly interest rate of 6% on loans, with the fees and additional costs included, you'll actually pay them 6.14%. This 6.14% is what is called the Annual Percentage Rate. Have you thought what type of interest rate you want the loan to have?'
Eric:'Well, I thought about variable rate. You know, an interest rate which can go up and down because of the changes in inflation.'
Peter:'That's one option. There's also fixed rate, where the interest rate you pay on the loan stays the same throughout the whole repayment period of the loan. Then there's split rate, where part of the interest you pay is variable and the other part is fixed.'
Eric:'I'll have to look into it. I've heard about a preferential rate. What type of interest rate is that?'
Peter:'If you are an existing customer of a bank or lending institution, sometimes the bank will offer you an interest rate on a loan that is lower than what they normally offer. This is what a preferential rate is.'
Eric:'Ok. I'll speak to my bank.'
Peter:'Eric, what you must do when deciding on choosing a loan is to look at the terms and conditions for it.'
Eric:'That's the loan contract information, which people often call the small print.'
Peter:'That's right. You need to read it. It contains all the information about the fees that you have to pay to the bank for the loan. You know the additional costs like processing the loan application or for administration. Also, in the terms and conditions you'll find what the charges are. This is what you have to pay the bank if one of your repayments is late. For some loans, the charges can be really high.'
Eric:'I don't think I'll have a problem repaying it. In fact, I should be able to pay off the loan early. Although I'm going to ask for a 4 year repayment period, I should be able to pay the loan off in a little over 3 years.'
Peter:'That could be a problem. Have a look in the small print to see what it says about redemption penalties. Some banks and lending institutions charge you money if you try to repay the loan back early. These are called redemption penalties.'
Eric:'Thanks, I will.'