While the door to cheaper mortgages is creaking ajar slowly, it has been flung wide open when it comes to personal loans. Interest rates have been tumbling and the cost of borrowing has now reached a record low. Last week Derbyshire building society reduced the rate on loans of at least £7,500 to 5% after Sainsbury's Bank lowered its to 5.1% last week on the same amount. This compares with a best-buy rate of 7.9% on a £5,000 loan last year and a rate of 8.4% in 2011, according to data researcher Moneyfacts.

With an unsecured personal loan you are borrowing at a fixed rate over a set period – typically one to seven years. Unlike a secured loan, the debt is not attached to your property so you don't have to be a homeowner to get one and there's usually no arrangement fee. So what are the best deals out there – and what are the potential pitfalls?

Cost of borrowing

Oddly, it can be cheaper to borrow slightly more than you want. This is because interest rates drop sharply at around the £7,000 to £7,500 mark. For instance, you'll pay £1,183 interest on £6,500 from Sainsbury's bank at 7% but only £969 from Derbyshire on £7,500 at 5%. However, because you are borrowing more the monthly repayments are higher, so you need to be sure you can afford it before you apply.

"Four years ago the lowest rates overall were on a par across all borrowing amounts," says Charlotte Ashton of Moneyfacts. "Today, there is a substantial difference across the tiers with the cheapest rates focused on the medium borrowing amount."

If you want £7,500, the best buy from Derbyshire, taken out over five years, will cost you £141.15 a month, or a total of £8,469 over the term. This is compared with £141.48 a month at 5.1% interest from Sainsbury's bank giving a total repaid of £8,489. However Sainsbury's has a price promise that it will beat any lower rate you're offered.

The cheapest rate on a loan of £6,500 is from Hitachi Capital, which charges 6.5%. This means monthly payments of £128 over five years and a total cost of £7,706. Unusually, this applies to loans from £2,500 to £15,000 – banks usually charge around 20% for small amounts of £2,500 – and there's no early repayment charges. The next cheapest deals are from Santander at 6.9% and Sainsbury's at 7% on loans between £5,000 and £7,500.

The quicker you can afford to repay your loan, the lower the cost. You'll pay back a total of £7,141 on £5,000 with the Santander loan over five years but only £5,532 over three.

Secured loans

These are also called homeowner loans as the amount you're borrowing is secured against your home. This means there will be a second charge put on your property – your mortgage is the first charge – so always remember that if you can't keep up the payments, you could lose your home.

They're designed for larger amounts of £50,000 or above and are, typically, taken out to consolidate other debts, or to pay for home improvements. Secured loans are not cheaper for medium size loans and most of them have penalties if you pay back early.

For instance, you'll be charged £7,500 over five years at a rate of 8.1% at Nemo Bank and 8.9% with Shawbrook Bank.

Finding the best deals

All the interest rates quoted are "representative" and there is no guarantee you will get the deal you see advertised.

However, the headline rate has to be available to at least 51% of applicants. Only those with a good or excellent credit rating will get the best on offer.

It's difficult to shop around because each time you apply for a loan your credit record is checked, which will leave a footprint of the search.

Too many searches will damage your record, making it even harder to get the cheapest rate. You can get a "soft" search which doesn't show on your record. Moneysupermarket.com, for instance, has "smart search" which shows the loans you are most likely to get based on your credit profile without denting your credit rating.

"The best deals are generally only available to consumers with excellent credit histories," says Tim Moss of Moneysupermarket.

"Before applying for a loan, or for any credit product, it's a good idea to check your credit history so you have a clearer idea of the products you are more likely to be accepted for based on your credit score."

Several credit reference agencies such as Equifax, Credit Expert and Checkmyfile will give you a free trial for 30 days to see your file but don't forget to cancel it at the end or you will end up paying.

Apart from a time limit on the best deals, you need to watch out for penalties if you overpay or repay the whole amount early. Most lenders don't penalise you for overpaying but it's normal to be charged one or two months interest if you pay off the full amount early.

Never miss a payment without agreeing it with the lender first or the interest rate could be raised. Also, missed payments will show up on your credit record, making it more expensive to borrow in future.

Some banks will only give personal loans to existing customers – these include HSBC, First Direct and Halifax. First Direct charges 5.1% on loans between £7,000 and £15,000, while HSBC charges 5.9% on the same sums.

Halifax borrowers can get a rate of 6.8% on loans between £6,000 and £15,000.

If they say no