How Do Personal Loans Work? A Comprehensive Guide Personal loans are a great way to access funds when you need it. They can be used for virtually any purpose, including consolidating debt, paying off medical bills, making home improvements, and even making major purchases. Knowing the basics of personal loans can help you determine if they are the right financial tool for your needs.
What is a Personal Loan?
A personal loan is an unsecured loan borrowed from a bank or online lender that allows borrowers to access funds to cover large expenses or consolidate debt. Unlike a secured loan, you don’t need to put up collateral (like your house or car) to use it. Personal loans can be used for nearly any type of expense.
Types of Personal Loans
The two main types of personal loans are fixed-rate loans and variable-rate loans.
Fixed-rate Loans:
A fixed-rate loan means the interest rate stays the same throughout the entire loan term. This makes budgeting easier as you don’t need to worry about when the rate might change. Fixed-rate loans usually require a good or excellent credit score as well.
Variable-rate Loans:
A variable-rate loan is one where the interest rate can fluctuate according to the movements of a benchmark rate. The interest rate on a variable-rate loan can be initially lower than on a fixed-rate loan, but it can increase or decrease over time. Variable-rate loans may be best for those who plan on paying the loan off early or have a lower credit score.
Interest Rates and Fees
The Annual Percentage Rate (APR) of a personal loan is the total cost of the loan and includes both the interest and any fees associated with the loan. It’s important to compare the APR of different loans to be sure you’re getting the best rate.
Interest rates on personal loans depend on a variety of factors including your credit score, the length of your loan, and the amount you borrow. For those with good credit, interest rates typically range from 4%-36% APR. For borrowers with less-than-perfect credit, rates may be higher.
It’s also important to check for any fees that may be associated with the loan. Fees can include an origination fee, late payment fee, or prepayment penalty fee.
Terms and Terms Length
Terms can refer to a variety of loan-related components, including your interest rate and the length of your loan. Generally, personal loan terms range from 12 to 84 months depending on the amount borrowed and your creditworthiness.
Qualifying for a Personal Loan
To qualify for a personal loan, you’ll need to meet the lender’s criteria. Requirements vary by lender, but typically you’ll need to provide your Social Security Number, proof of income, and details about your employment and residency.
Your credit also plays a major role in determining if you’ll qualify for a loan and what interest rate and terms you will be offered. For those with excellent credit, lenders may offer lower rates and more attractive terms. Those with less-than-perfect credit will generally have a higher interest rate, but may be able to get approved.
Applying for a Personal Loan
The first step in applying for a personal loan is to do your research. You’ll need to compare offers from different lenders to find the best rate and terms for your needs.
Once you’ve done your research and chosen a lender, you can apply. To apply, you’ll need to provide the lender with your personal, financial, and employment information. Generally, you can apply online or at a branch.
Once the lender reviews your application and approves the loan, they’ll need to verify the information you provided. This is done through a process called “verification of deposit”. The lender will contact your bank to confirm that the funds are available.
Once the lender has verified the information, they’ll fund your loan. Depending on the lender, you may get the funds as soon as the next business day
Pros and Cons of Personal Loans
Before getting a personal loan, it’s important to weigh the benefits and drawbacks.
Pros:
-Can help consolidate debt
-Quick and easy access to funds
-Lower interest rates for those with good credit
-Can be used for nearly any purpose
-Flexible payment terms
Cons:
-May require good or excellent credit
-Higher interest rates for those with bad credit
-Origination fees, late payment fees, and prepayment penalties
Using a Personal Loan Wisely
Using a personal loan to access funds isn’t always a wise choice. It’s important to consider how much you can afford to repay before taking on a loan. If the loan payments exceed your monthly budget, it’s likely you’ll struggle to make the payments.
It’s also important to look for the best loan for your financial needs. Shop around and compare the interest rates, fees, and terms of different lenders. That way, you can make sure you’re getting the best deal.
Finally, it’s important to be prepared for any loan you take out. Personal loans are a serious financial commitment and they should not be taken lightly.
Personal loans can be helpful when used wisely. Before getting one, it’s important to do your research. Shop around and compare offers to make sure you’re getting the best deal before taking out a loan. Knowing the basics of personal loans can help you decide if they are the right financial tool for your needs.
