How Do Personal Loans Work?
A personal loan, just like a mortgage loan, is a form of credit helping borrowers to either consolidate their debts or make a significantly large purchase. Since this type of finance comes with a lower interest rate than credit cards, it is recommended to take out a personal loan to consolidate multiple credit card debts into a single monthly low-cost payment. Applying for a personal loan does affect your credit score and therefore, you must consider the advantages and disadvantages of this type of credit before applying.
What is a Personal Loan?
A personal loan is the amount of money borrowed from a financial institution or online lenders, typically on a fixed monthly payment term that lasts from 1 to 5 years. Most of the personal loans offered are unsecured, however there are credit providers who offer secured personal loans as well.
Secured Loans vs Unsecured Loans
A secured loan is a form of credit that is backed by collateral. Just like how a home equity loan is backed by the value of the house you own; a secured loan can be issued to a borrower against their car or house. This reduces the risk of lending for loan providers in case a borrower goes bankrupt or defaults on their payments. These types of loans tend to have lower interest rates than unsecured loans and have higher borrowing limits.
An unsecured personal loan is a form of credit that does not have any collateral associated with it. If a borrower defaults on their payments or goes bankrupt, the lender cannot take their property automatically. Student loans, credit cards and personal loans are all types of unsecured loans.
There are a few things to consider when choosing between the two types of loan. If you have a poor credit score or looking for cheaper credit and willing to put up your car or house as a form or credit, then consider applying for a secured loan. Otherwise, opt for unsecured loans.
Benefits of Personal Loans
They Have Many Uses: With a personal loan, you are not restricted to what you can use the loan for. Be it a holiday, an unexpected medical bill or simply a wedding finance, you are not tied to one specific purpose unlike other forms of credit, for example, a car loan can only be used for purchasing a car.
Flexible Term: A personal loan is flexible and gives you the power to choose how much money you want and how long you’d like to repay it. However, this is dependent upon your credit score and will affect the interest rates you get.
Consolidate Existing Debts: Personal loans can be used to pay multiple debts while you are left with a single loan and single monthly payment. This is convenient and helps borrowers to be on top of their finances.
Instant Access to Cash: Personal loans are much easier to secure cash than a mortgage or other forms of credit. Simply apply online and receive your funding within a couple of days of approval. In comparison, funding with mortgage can take up to 3 weeks or even more depending on your situation.
Fixed Rates and Repayments: Personal loans typically have fixed interest rates. This means if the market conditions plummets, your loan terms remain the same. With fixed rates, you are required to pay fixed monthly payments to your lender making it easier to manage your budget.
Drawbacks of Personal Loans
Fixed Payments: Unlike credit cards, personal loans come with fixed payments. Fixed payment is considered as a benefit since it helps with managing your budget, however if you fail to meet these payments, it can become a disadvantage as the lender can sue you for non-payment.
Origination Fees: Besides interest, borrowers need to pay origination fees which can range between 1% to 6% of the loan amount. This amount cannot be paid over time and needs to be serviced upfront which can create issues for borrowers who don’t have money in the first place.
What is the difference between an interest rate and an APR?
Interest rate is the amount of money you are charged for borrowing. This does not include origination fee or any other lender associated fees. While on the other hand, APR is the amount charged for borrowing, inclusive of all fees.
What is a floating rate loan?
Personal loans typically have fixed interest rates however there are some loans that allow for floating rate. A floating rate allows the rate to fluctuate after an initial period, which could be 1 year. The rate varies according to the market conditions and you might be required to pay lower or higher monthly payments depending upon the situation.
How soon can I get my money after my loan is approved?
This depends on your loan provider. Every lender has a set of guidelines that they follow and a checklist they need to go through before approving a loan. This can take as little as 24 hours or can go as long as a month. To speed up the loan process, it is recommended that you have all your documents ready before applying.
If I have less than perfect credit, can I get a loan?
The minimum average credit score for personal loans is around 640. The higher the credit score, the lower will be the interest rate on your loan. If you have a score less than 620, you can still get a loan but with subprime and payday lenders only, which can be really expensive considering that the rates range anywhere between 29% and 400%.
When should I get a personal loan?
This depends on a few situations. If you are getting a loan with cheaper terms than a credit card, then it makes sense to take out a personal loan or if you are looking towards consolidating all your debts into a single monthly payment, then it is recommended that you go for a personal loan. If you really need money to make a big purchase but can comfortably pay the monthly payments without significantly impacting your budget, then consider taking out a personal loan.
We do suggest putting the personal loan towards a use that has the potential to increase your financial standing like buying assets or paying off previous loans rather than using the loan for a vacation.
What to Consider when Applying for a Personal Loan?
There are certain things to consider when applying for a personal loan such as:
- You need to make sure that you are eligible for the loan you are applying for. Some of the basic personal loan requirements are:
- You are 18 years or above
- Have a regular income
- Resident of the United States
- Details of current financial situation
- You need to think about what you want to use the loan for. There are many types of loans that are taken out for different uses, for example, a personal loan can be taken out to consolidate all your debts into a single payment while a car loan can be used to buy a car since they have lower interest rates than a unsecured personal loan as the vehicle is used as collateral. Other reasons why people choose to get personal loans is because of weddings, home renovation, business expenses, etc.
- You need to search for a loan that can offer you the lowest possible rate. Interest rates are dependent upon your credit score and financial details, but most importantly, it depends on the type of loan you go want. For example, a secured loan will have a lower interest rate since an asset is used as a collateral.
- There are several fees associated with personal loans, hence you need to do your research on which loan costs are associated with each lender. Some of the basic fees that comes with a personal loan are:
- Origination fee
- Late fee
- Prepayment penalties
- It is important to understand the terms of the personal loan since it determines the amount of interest you pay over its life. A loan with longer payment periods might have lower interest rates compared to shorter term loans, however, the total interest is considerably higher.
How To Compare Personal Loans
Personal loan comparison has never been so easy as we have featured a range of brands on this page for you in the table above. Each of these brands have their own separate detailed review that you can go through to get all the necessary information regarding APR, payment terms, credit score and more. You can compare this data with other brands and see which one is better suited to your needs.