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Published 16 May 2023

What is a Bank Loan? How Do They Work?

Bank loans work similarly to loans from other lenders, but often require good or excellent credit to qualify.

Bank loans work the same as personal loans you can get from online lenders. After you apply, the bank will review your credit score, history and income to determine how much money to loan you and what annual percentage rate (APR) you qualify for.

Once you get the loan, you’ll pay it back in monthly instalments. Typically, bank loan repayment terms range from about one to seven years but this will vary between banks.

The amount you can borrow will depend on the bank and your individual situation, but you can usually find loans ranging between £1,000 and £25,000. You may be able to borrow more if you are an existing customer, for example.

As well as personal loans, some banks also offer business loans.

Who can get a loan from a bank?

Some banks may only offer personal loans to their existing customers, while others will accept loan applications whether you’re a customer or not. If you already have an account and are in good standing with your bank, you may be offered a loan with a lower APR or be able to borrow more.

Banks typically require a borrower to have a good or excellent credit score, a stable income and a low debt-to-income ratio to take out a personal loan. If you don’t think you’ll qualify for a bank loan, you can look for ways to improve your credit score which could help you get approved.

Banks aren’t the only places that offer loans. There are also a wide range of alternative lenders that can provide loans to people in many different circumstances, including those with a bad credit history. 

You may also consider other types of loans, such as a secured or guarantor loan, that may be easier for someone with poor credit to access.

Credit union loans often have similar features to bank loans, such as low interest rates and flexible repayment terms, but can be an option for people with fair and poor credit scores.

Uses for a bank loan

Bank loans can be used for almost any reason. Common uses include a new car, special occasions, home improvement projects and debt consolidation

Lenders may allow you to use a personal loan to refinance an existing loan. This is when you take out a new, cheaper loan to pay off your existing loan. Refinancing can make sense if the new loan has a lower rate than the loan you already have, so you end up paying less interest overall.

Lenders will typically state that you can’t use a bank loan for certain purposes, such as illegal activities, gambling or buying property, for example.

Is getting a personal loan a good idea?

Depending on what you plan to use it for, a personal loan could be a good idea if it can help you reach your financial goals without putting you in financial jeopardy. It could also help to build up your credit history, provided you make payments on time and effectively manage the rest of your finances.

Borrowing to cover the cost of everyday expenses and bills is unlikely to be a good idea as this indicates that you may struggle to repay the loan.

If you don’t think you could afford to repay the loan on time, getting a loan could do more harm than good as you may find yourself in a cycle of debt. Missed loan payments could affect your credit score and the lender may also charge late payment fees.  

If you’re struggling with your finances, it may be worth contacting a debt charity for free help and advice on your situation.

How can I improve my chances of getting approved?

If you’re worried your credit score is too low to get the loan you want, there are a few steps you can take to help you get a personal loan:

  • Check your credit report regularly: All credit reference agencies (CRA), such as Experian, Equifax and TransUnion, must allow you to view your credit reports for free. You can then get a better idea of how to improve your score and if you see any errors on your reports, you can contact the relevant CRA to try to get the issue resolved.
  • Be consistent about making payments on time towards all of your debts: This will help improve your debt-to-income ratio and build up your payment history, all of which impact on your credit score.
  • Only apply for the amount of money that you need: Requesting more than you need means you’ll be making higher loan payments each month, which can jeopardise your budget and ability to pay your debts.
  • Consider finding a guarantor: If you don’t think you’ll be approved for the loan you want from the lender of your choice, adding a guarantor with a higher credit score and income can boost your approval chances.

» MORE: Tips for applying for a loan

Applying for a loan from a bank

Some banks allow you to use an eligibility checker to find out how much you can borrow and what rate you might qualify for without affecting your credit score. This is a good idea as submitting an application will trigger a hard credit check, which could have a negative impact on your score.

Once you’ve compared banks and decided which you would like to borrow from, you’ll fill out an application. The bank will then run credit and affordability checks to see whether to accept your application, and if approved, what rate to offer you. 

It’s also worth comparing loans from other lenders, as they could be a better option for you than a loan from a bank.

» MORE: How to get a loan

Image source: Getty Images

About the Author

Annie Millerbernd

Annie is a personal loans writer at NerdWallet. She previously worked as a content strategist for USAA and as a data reporter for the San Antonio Express-News.

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