How to choose the right personal loan

Do you need to borrow money? I'm going to help you decide whether a personal loan is the right choice for you.

It's difficult

It is becoming increasingly difficult to get a personal loan, recent research indicates.

According to the Finance and Leasing Association, personal loans (also known as unsecured loans) have been walloped by the credit crunch, with 45% fewer loans being granted this year.

In a nutshell, the two main reasons for this trend appear to be a.) lenders' unwillingness to give credit and b.) an increasing consumer reluctance to borrow.

At the moment, personal loan interest rates start at around 8% APR, depending on the amount you want to borrow and over what period.

The Sainsbury's Finance Personal Loan is currently offering one of the lowest rates on the market - 7.9% APR on £10,000, to be repaid over 60 months.

Your borrowing options

Of course, faced with a shaky economy and rising unemployment, we should all try to avoid getting into debt if we possibly can.

However, if you've decided you definitely need to borrow some cash, here's a quick rundown of your main options:

0% cards

If you're looking to buy something you can pay for on a credit card, and only need a few thousand pounds, a 0% purchase credit card could well be your cheapest way to borrow.

This sort of card offers you 0% interest on all new spending for a set period of time. The current market leader is the Marks & Spencer Money Mastercard, which offers 0% on purchases for a very decent 10 months.

Alternatively, if you need to get your hands on some cash, you could get the Virgin Money 0% balance card. This card allows you to transfer cash directly into your bank account, for a 4% handling fee. And the interest-free period is much longer than M&S Money's - 0% for 16 months.

On the downside, neither of these cards offer a long-term borrowing solution, because if you haven't paid off the debt by the time the 0% deal ends, you'll be charged a hefty rate of interest (typically around 16% APR) on the remaining balance.

To find out more about 0% borrowing on credit cards, read The cheapest way to borrow a grand.

Current accounts

Another way to borrow a small amount of money cheaply is to switch your current account and use the interest-free overdraft facility your new one provides.

For example, the Premier Direct current account from Alliance & Leicester offers an interest-free overdraft facility of up to £2,000 for 12 months after you open the account.

Again, this is only a short-term borrowing solution. When your interest-free period ends with the Premier Direct account, you'll be charged an overdraft 'usage fee' of 50p a day (up to £5 a month).

Other current accounts may not charge usage fees - but they're likely to charge high rates of interest on your remaining debt instead.

Secured loans

A secured loan is 'secured' against your home. That means if you fail to keep up with your monthly repayments, you could literally lose the roof over your head. This is a huge risk to take, and I would steer clear of secured loans if you possibly can.

Plus, at the moment, secured loans don't even represent a particularly cheap borrowing option. As my colleague Cliff D'Arcy argues in this article, although the base rate has plummeted, secured loans aren't getting much cheaper.

Social lending

If you'd rather sidestep traditional forms of borrowing altogether, you might want to join Zopa. This 'social lending' business lets you borrow from other consumers, rather than from banks.

Zopa offers loans of between £1,000 and £15,000 - lasting either 36 or 60 months. The rates you're offered will be set by the consumers lending the money, and will be based on your creditworthiness.

Zopa loan rates are generally competitive, and if it turns out you can pay your loan off early, you won't be faced with the early repayment fees usually associated with bank loans.

On the downside, the lending criteria are stringent, and you'll need a decent credit score to be accepted for a loan. To find out more about Zopa, read this article by my colleague Jane Baker.

So when is a personal loan right for me?

As you can see, the right loan for you will depend on your own, very personal circumstances. As a rough guide, if two or more of the following statements apply to you, a personal loan could well be your best option:

• You need more than a year to pay off your loan;

• Your credit score won't allow you to take out a 0% credit card or a Zopa loan;

• You want to borrow a relatively large amount of money (more than that offered by a typical credit card/overdraft limit);

• You don't want to risk your home by committing to a secured loan.

If you've decided to take out a personal loan, you now need to know about the good features to look for and the pitfalls to avoid.

To get on the right track, read Three steps to a low-cost loan by Cliff D'Arcy, and 15 tips for using unsecured loans, by another lovemoney.com colleague, Neil Faulkner.

Good luck!

More: Payday loans are the devil in disguise | Student loans to cost more than inflation

Compare personal loans with lovemoney.com.