Millions of Americans every year opt for small personal loans for all kinds of reasons. Major reasons include consolidating debt and unexpected emergency expenses.
Credit cards are one form of personal financing that involves borrowing (a kind of loan) and variable interest rates. Likewise, personal loans are also becoming a more common choice, especially with the ease of acceptance with online applications.
Personal loans are growing in popularity, and over 20.2 million personal loans are issued in America. This is because many have more affordable interest rates than credit cards, making them more ideal for big purchases and large unexpected expenses like medical costs, funerals, or to cover costs during sick leave.
Ahead of applying for a personal loan, it is crucial to sit down and take a look at your debts and assets. Consider how much you will be needing, and have an honest look at whether the repayment schedule will work for you and your lifestyle. For any of the millions of people considering taking out a personal loan, here is everything you need to know.
What is a Personal Loan and How Does Repayment Work?
Personal loans are typically given as a lump sum to applicants who meet the lender’s qualifications. Loans usually have a fixed period for repayment and a fixed interest rate. The amount of time and the interest rate dictate the repayment schedule.
The one type of loan that does not work this way is a personal line of credit. A personal line of credit works like another bank account where the borrower can draw funds as needed up to a certain limit. However, there is still an interest rate applied to repaying a personal line of credit. Another difference is that the interest rates on personal loans often vary with market rates.
The application process for a personal loan is similar to that of a credit card. A prospective borrower will need to supply the lender with personal details, banking information, and sometimes some explanation of the need for the loan.
Your details and banking information will be used to look up your credit score. Credit scores are rated from 300 to 800. Lenders typically will not loan money to anyone with a credit score of less than 660. This is because a credit score indicates the likelihood that a person will repay based on their past behavior.
Once approved, the borrower will receive the lump sum loan, usually directly deposited into their bank account.
Types of Loans
There are many different types of loans to choose from, and there are more choices for those with more assets that can be leveraged. But there are two major categories of loans: those that are secured and those that are unsecured.
- Unsecured Loans are the most common type of loan for individuals. This type of loan does not require leveraging personal assets, so they are great for those just trying to get ahead. These loans are great for a big purchase or a significant debt repayment. Lump-sum bank loans and personal lines of credit are examples of unsecured loans.
- Secured loans are protected by collateral, which means you will have to put up your assets to guarantee repayment. In other words, if you default on this type of loan, the lender may take the asset instead. Examples of secured loans include mortgages, home equity lines of credit, or car title loans.
Whichever type of loan is opted for, there will be interest rates to consider, as well as fees and penalties if a payment is missed.
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Loan Interest Rates and Fees
Some personal loans have a small sign-up fee. Almost all loans will have a default fee. Other than that, the only other costs to expect are the interest rates.
The interest rates on personal loans are usually locked in. This is great news if the interest rates happen to be low but not as ideal when they are higher.
Some loans offer variable rates, so if interest rates are higher at the time, a variable rate could be the smarter option. However, variable rates can be harder to account for when budgeting a few months out because you will not know the exact payment.
Pros of Getting a Personal Loan
Lower interest rates than debt:
- If you are looking to consolidate credit cards or other debt, then a personal loan could carry a lower interest rate, meaning it will cost you less to pay down the debt with a personal loan.
Higher Borrowing Limits:
- Personal loans typically can be as high as $50,000. With secured loans, they can go even higher. This is much higher than the limit on many people’s credit cards, meaning that when needed, even more capital can be leveraged. This is especially ideal for significant purchases and expenses.
Flexibility and Security:
- Some people like to have a lot of extra security for unforeseen expenses. Whether because of a precarious job, or a big trip, or while you or your child are in college, it can be worthwhile to have the peace of mind that if anything comes up, you can cover it right away.
Cons of Getting a Personal Loan
Some Interest Rates Can Be Too High:
- If your credit score is quite low, or if market interest rates happen to be high when you sign for the loan, then you can be stuck with a prohibitively high-interest rate. It can be hard to predict interest rates or when you suddenly need a personal loan. This is why it can be helpful to have a line of credit available for these times.
Fees and Penalties:
- Without proper financial planning, you might end up having to pay late fees and penalties. Some loans will also charge application fees, originator fees, and even prepayment penalties if you pay back the loan too soon. It is critical to read all the fine print on any new loan to know what you are in for.
- Again, without proper financial planning, you can default on your loan racking up late fees, and end up with as much or more debt than you had before.
Personal loans are a great way to cover interim costs and even help you get ahead with your personal financial goals. When it comes down to taking out any loan, it should begin with an analysis of why you need the funds and if you can repay the money in the time allotted to you.