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As the name suggests, a personal loan is used for individual needs or wants of the borrower’s choosing. Unlike a mortgage or boat loan, it is not approved for a specific purpose. People take out personal loans to pay for vacations or weddings, for instance. Other reasons borrowers get them are to make home improvements, consolidate credit card debt, or if money is needed for a sudden emergency.
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The term personal loan simply means that the applicant is borrowing money for his or her personal intentions. However, there are several types of personal loans under this general heading. Each has different interest costs, terms, and other factors. Below are samples of common personal loans and how they can be used.
Secured and Unsecured Personal Loans
Personal loans fall into two main categories; namely, secured and unsecured. It is important to know the difference since each has advantages and disadvantages which can affect a borrower’s overall financial picture.
Unsecured loans do not require a form of collateral to get approval, such as a house or vehicle. This can be an advantage for people who do not own homes or vehicles but need a personal loan. Another plus is there is no risk of losing a home or other security since nothing is put up as collateral. One disadvantage of unsecured loans is that interest rates tend to be higher because the lender is assuming more risk.
Secured loans are approved with the contingency that property or other possessions are held as guarantee of payment. The advantages of a secured loan may include lower interest and payments. Also, people with bad credit may get approval for a personal loan if they have security to offer. The chief disadvantage is that the lender places a lien on the property used as collateral. This means that, until the loan is paid in full, the lender has a right to take possession of the asset if the borrower defaults.
Just like auto loans, business loans, or any other credit, the amount of interest charged depends on a set of variables. These include credit score, income, and which lender is funding the loan. Careful consideration should be given to this aspect of the personal loan process due to the impact of the cost interest over the course of the loan. Each lender is different, so consumers should take advantage of the tools that can be used to research a variety of lenders prior to making a commitment.
Although the interest rate for individuals differs, there are two primary types of interest with regard to personal loans:
How do these two types of interest compare? Why would a borrower choose one over the other? Some pros and cons of fixed and variable rate interest:
Some variable loans do have caps which limit how much the rate can change during the life of the loan. Lines of credit tend to come with variable interest rates. On the other hand, installment loans mostly carry fixed rates.
Signing on the dotted line with a promise to repay any type of debt should not be taken lightly. Borrowers can increase their success with personal loans by knowing that:
Experts say that one sure way to get into financial trouble is by agreeing to unfavorable terms or rates out of desperation. An ill-prepared borrower can wind up with threatening collector calls or wage garnishments because of an inability to pay. Even worse, secured personal loans that are not paid result in loss of property and potential legal fees. The risk of these consequences is lower when a borrower has weaponry in the form of accurate information and advance preparation before they even approach a lender.
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