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.
Topics on this subject:
Types of Personal Loans
Secured and Unsecured Personal Loans
Need to Know
Types of Personal Loans
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.
Installment loans. Approved for a set amount and paid back in equal payments. They are also known as signature loans and can be secured or unsecured. Installment loans are a good choice for paying one-time expenses like medical bills, home projects and debt consolidation.
Short term personal loans. These loans, by far, come with the most expensive fees and interest. Payoff is required more quickly than other loans. Other names for these loans are payday loans and title loans, in which a vehicle is used as collateral. People with bad credit may take out short term personal loans to tide them over in a financial crisis.
Credit line. This is a type of flexible loan option in which the borrower can take out as much or as little of its limit they choose. Interest is only paid on the amount used. Lines of credit can be used to pay recurring bills like school tuition.
Cash advance. Taken from a credit card, cash advances can be considered as a personal loan. Like a short term loan, the interest is usually much higher than using the credit card to make purchases. In addition to interest, they also come with fees. The fee amount is based on how much money is drawn on the card.
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:
Fixed rate, which is locked in for the life of the loan without change.
Variable rate interest fluctuates throughout the loan term based upon changing financial market indexes.
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:
Fixed rate payments remain the same until the loan is paid; variable rates cause payments to go up and down.
Variable rates provide an opportunity for payments to decrease when rates are low; fixed rates stay the same even when the market rate drops.
On average, fees and rates are lower with variable rate personal loans (at least until interest rises); fixed rates tend to be higher initially.
A fixed rate loan is easier to budget; variable rates may lead to financial strain when interest rates soar.
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.
Need to Know
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:
Lenders sometimes approve loans for more than the borrower asks. It is never a good idea to borrow more money than is needed. Applicants can decline the extra money to avoid added interest and more debt.
Research is the key to choosing a personal loan that works best for the individual. Borrowers should search through multiple lenders to see what they charge for fees and interest in addition to comparing terms offered for each loan.
While taking a luxury vacation using a personal loan is a great idea for some people, people who have high interest debt or unpaid medical bills may want to reconsider using the loan for those purposes instead.
Before applying, the borrower should know their credit score to avoid any nasty surprises. A bad credit loan may cost more than the borrower can comfortably afford. It may be wiser and cheaper to consider alternatives like borrowing from friends or family. Or, if possible, wait to apply until the credit score is built up in order to get better rates.
Even though the majority of online lenders are legitimate, there is more than a fair share of lending scams on the Internet. Caution is crucial since a loan application involves giving out loads of personal information. Signs of a possible personal loan scam include lenders who ask for a deposit to secure a loan, or who guarantee an approval without a credit check credit or any paperwork, and a lender who is extremely pushy in trying to get the borrower to commit to a loan.
Each step of the personal loan process impacts credit one way or another. Applying for a personal loan adds an inquiry to the credit report-too many inquiries can lower the score. A loan approval is an opportunity to boost the credit score by making timely payments consistently.
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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