Personal loan: Everything you need to know

Personal loans can be helpful, but it’s important to understand how they work. (iStock)

Personal loans can be useful for meeting a variety of financial needs when using a credit card or paying cash is not an option. A personal loan is a type of installment loan, which means that as you make payments, the balance decreases until it reaches zero. If you’re considering a personal loan for any reason, here’s what you can expect.

Types of personal loans

A personal loan can be secured or unsecured. A secured loan requires collateral, unlike an unsecured loan. For example, some banks and credit unions offer savings-backed personal loans, where a savings account or certificate of deposit serves as collateral.

SHOULD YOU GET A PERSONAL LOAN TO PAY OFF CREDIT CARD DEBT?

As for the benefits of a personal loan, here are some of the most common uses:

  • Debt Consolidation
  • Home improvements
  • Medical bills/expenses
  • Wedding expenses
  • Vacation costs
  • Moving expenses
  • Vehicle financing
  • Veterinary bills
  • Tax debt

Although you can get a personal loan for student debt consolidation, it’s usually not the best option. If you have federal student loans, for example, converting them to a personal loan would mean losing the ability to defer payments or take forbearance, if necessary.

Personal loan conditions

When checking personal loan offers, it is important to pay attention to the terms of the loan. Concretely, this means:

  • How long you have to repay the loan
  • The amount you are allowed to borrow
  • Your interest rate on the loan
  • Any fees charged by the lender for the loan

Personal loans can have a fixed or variable interest rate. Fixed rate personal loans carry the same rate for the life of the loan. This allows predictability when budgeting monthly payments and it is possible to calculate the total amount of interest paid up front.

PERSONAL LOAN OR CAPITAL LOAN: WHICH IS BETTER?

Variable rate personal loans can see the rate rise or fall over the term of the loan, depending on movements in an underlying benchmark rate. If the rate increases, payments could increase, as could the amount of interest paid.

Credit history is one of the most important factors in determining personal loan interest rates. Lenders are more likely to offer better rates to borrowers with a higher credit score, while a lower credit score could trigger a higher rate.

How to apply for a personal loan

Applying for a personal loan begins with choosing a lender. Remember that personal loans can be offered by banks, credit unions, online lenders and peer-to-peer lenders.

HOW TO APPROVE A PERSONAL LOAN

The next step is to complete the application. Lenders typically ask for this type of information when applying:

  • Last name
  • Address and telephone number
  • Date of Birth
  • Social Security number
  • Employment status and income
  • Amount of loan requested and purpose of loan
  • Monthly rent payment

Lenders may also ask for supporting documents, such as bank statements or pay stubs to back up financial information. The lender may make a soft credit application first, followed by a hard application for your credit score and reports.

Advantages and disadvantages of personal loans

Personal loans can help bridge cash gaps relatively quickly and for borrowers who qualify for the lowest interest rates, they can be a cheaper alternative to credit cards. They offer flexibility, in that personal loans can be used for almost any reason and excellent credit is not required for approval.

On the other hand, personal loans can be expensive for borrowers whose credit does not allow them to lock in the lowest rates. And some borrowers may be denied outright if they do not have sufficient credit.

Finally, personal loans may not be an effective debt consolidation tool for borrowers who end up accumulating new debt after taking out the loan.

About Judith J. George

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