What is a Personal Loan?

A personal loan can be considered as money borrowed from various financial institutions like banks, credit unions, or even online lenders. The money is often fixed to be repaid in installments or monthly payments, typically over 2-7 years.

The loan receiver is generally qualified based on credit history and income. Personal loans are also known as a signature or unsecured loans as they typically don’t require any collateral against the loan amount.

Personal loans are much easier to apply and qualify for than other loans. This makes them incredibly useful for many things, such as small monetary needs and expensive purchases.

What is a personal loan used for?

Personal loans are generally applicable on many occasions. Common uses include covering medical bills, debt consolidation, refinancing existing loans or home improvement projects. You can also utilize it for other purposes like financing a vacation, wedding, funeral or any large purchases.

Personal loan example

Personal loans are meant to help reach financial goals instead of further increasing a debt problem. Hence, it is highly recommended to use only when it may save you money, help increase the value of current assets or improve income-generating capabilities.

Take, for instance, home improvement projects, whereby the loan can help increase the home’s value. Even making large purchases for a business tends to increase your income rather than increasing debt. For $2,000-$5,000 loans, check this article.

Types of personal loan

Unsecured personal loans: These are not backed by collateral, like a home or car. It’s also the most common type of loan among borrowers and the riskiest among lenders, thus resulting in a higher APR (annual percentage rate).

  • Secured personal loans: These come with collateral, which allows the lender to seize whatever you put up against the loan if you cannot repay the loan amount. The collateral usually includes houses or vehicles but can include personal savings or other assets, depending on the lender.
  • Fixed-rate loans: Fixed-rate personal loans provide loans with a fixed rate and monthly payments that remain the same for the entire repayment duration.
  • Variable-rate loans: Variable-rate personal loans come tied to specific benchmark rates settled by the bank. Hence, the loan rate, monthly payment and total interest may rise or fall depending on the fluctuation rate.
  • Debt consolidation loans: This one combines multiple debts into a separate new loan, thus, leaving borrowers with only one monthly payment.

Personal loan interest rates

The interest rate on personal loans will normally vary depending on the location, credit score, lender, and even the year of application. According to the Federal Reserve, the average interest rate of personal loans (24-months) in August 2020 was 9.34%, and recently, in May 2021, the average rate was around 9.58% for a 2-year personal loan.

Before applying for a personal loan, you may also want to consider the factors that can influence your interest rate. If you want to pay less, you should maintain a high credit score. You can also compare different offers from different lenders to find which offers the lowest rate.

How to get a personal loan?

To increase the possibility of qualifying for personal loans, you need to have a solid credit profile. However, this doesn’t apply to all lenders, and many offer bad credit loans as well.

That being said, whichever lender you go through – be it a bank, credit union or online lender, the borrower must go through an application process. The lender will go through your credit score after the application is passed.

Hence, before you enroll for the loan, it’ll be helpful to review your credit score and credit report to understand what the lenders may notice when your credit scores and reports are pulled out. Since checking these doesn’t affect your score, you can check them frequently if you want.

Once your credit is reviewed, and any necessary steps are taken to improve it, you can pass the personal loan application to the financial institution. You’re your scores are reviewed, lenders generally qualify those with a higher score for better loan terms and even lower interest rates. The lender also reviews your DTI (debt to income ratio), which compares the monthly amount you’ll play against the total amount (income) you earn.

Personal loans are easy and simple to apply for and require only a few steps. You’ll have to first pre-qualify among multiple lenders to make a comparison on different offers. Pre-qualifying normally takes a few minutes by providing basic information like the purpose of the loan, the amount, desired amount of monthly payment and personal details.

After selecting the best offer, you can gather documents for a formal application. The documents usually include a photo ID, education history, proof of address, employment status, along with social security number.

Since most lenders now operate online, so you can quickly complete the application process through a phone or laptop. Once approved, the amount can be funded as early as the day of application in some cases.

About credit scores

Before initiating any important credit/loan application, it’s crucial to check and know your credit scores to get a gist of your current credit status. Every individual with social security numbers is entitled to see their credit reports once a year, and you can easily access your information through sites like annual credit report.

Summary

Personal loans do not vary much from other forms of debt. Hence, there must be a clear understanding of how it may affect your budget and how you can clear up with a proper plan to make repayments.

Personal loans may be a very common loan, but there’s a lot under its banner, and it’s important to gain a clear understanding of it before applying. We have covered the various aspects of personal loans through this article, and we hope it has been helpful.

 

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