Personal Loans

What Is A Personal Loan

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 7 minute read

The Lopezes couldn’t contain their elation at the prospect of a kitchen overhaul they’d been planning for over a year. The contractor’s estimate of $20,000 in costs for the job dampened their enthusiasm, though. They could put the entire amount on the credit card, but they realized that even with some creative budgeting, the most they could pay back each month would be $500. Considering the interest, it would take them about six years and cost them over $7,000.

The Lopezes were about to give up on their ideal kitchen renovation until their contractor suggested they look into getting a personal loan instead. They may qualify for a five-year loan at an interest rate of about 7% thanks to their excellent credit, which is far lower than the rate they’d be charged on a credit card.

In addition to being able to eliminate the debt more quickly, the reduced monthly payment of less than $400 would provide them a great deal of financial breathing room.

As a kind of debt financing, personal loans aren’t quite as prevalent as credit cards. While nearly 65% of adults in the United States applied for a credit card in 2016, just 10% sought a personal loan. In spite of this, they are becoming increasingly well-liked. According to TransUnion, the total amount of outstanding personal loans in the United States reached a record high of $107 billion by midway through 2017.

About Personal Loan

Credit card debt, which is revolving debt, is the most common kind of borrowing in the world. They provide you with a reserve of liquid funds from which to draw as required. With the minimal payment made each month, you have as long as you wish to pay off this loan, and the interest rate might fluctuate as time goes on.

Individual loans are not the same. They fall under the category of installment loans, when one borrows money and repays it in equal monthly installments over a certain length of time, such as one year.

Personal loans often have terms between two and five years, however they can be for as little as one year or as long as seven. Over the course of the loan’s duration, the interest rate remains constant. Generally speaking, a personal loan might be one of two varieties:

  • Individual Loans with Security. A secured loan is one in which the borrower pledges an asset (such as a home, automobile, or cash in a CD or savings account) to the lender as security for the loan. You risk having your collateral repossessed by the bank if you are unable to repay your loan installments.
  • Unguaranteed Individual Loans. Most personal loans are not secured by any tangible asset. Your creditworthiness is determined by the bank’s analysis of your financial history. There will likely be a higher interest rate attached to these loans due to the increased risk they pose to the lending institution.

Personal Loan Examples

People take out personal loans for a number of reasons. Here are some of the most common:

  • Consolidation of Debt When using a personal loan to consolidate debt, you borrow a big quantity of money and use it to pay off all your other bills, such as credit cards, school loans, and vehicle loans. Debt consolidation might make it easier to manage your money, since you will only have to keep track of one monthly payment instead of many payments to various creditors. A debt consolidation loan with a lower interest rate than your original loans can also help you save money.
  • Unanticipated Expenses Major unanticipated costs, such as expensive medical bills or extensive auto repairs, can devastate your budget. The most effective strategy to tackle such problems is to establish an emergency fund to meet the expenses. However, if you don’t have one or have already depleted it, a personal loan might be an excellent method to convert a large one-time cost into a series of affordable installments.
  • Home Improvements. Home improvements may be costly. According to Home Advisor, the average cost to rebuild a bathroom is $9,634, to remodel a kitchen is $22,011 and to create an extension is $42,070. Many homeowners don’t have this amount of cash on hand, so a personal loan might be a method to immediately complete the modifications and pay for them over time.
  • Wedding Expenses. Weddings are a significant one-time expenditure. Even though it is feasible to arrange a wedding on a budget, it is not unusual for American couples to spend $10,000 or more to have their dream wedding. A personal loan may be a more affordable option than credit cards for funding this significant event.
  • Vacation Expenses. Some individuals even obtain personal loans to finance their dream vacation. If you have a once-in-a-lifetime chance but lack the funds, a personal loan may be your next-best option.

Where to Look for a Private Loan

An individual can apply for a loan from a number of different institutions. A variety of financial institutions provide this sort of loan, including banks, credit unions, internet lenders like Payoff, and P2P lending platforms like Prosper and Lending Club. Even while borrowing from online and P2P lenders is more simple than ever before, not all loan programs are accessible to borrowers in every state.

Personal loan approval is contingent upon the lender’s assessment of the borrower’s financial situation, regardless of the lender type. Information such as your credit history, credit score, and debt-to-income ratio will be accessed from your credit report by the lender. With higher credit, loan approval and terms improve.

Personal Loan Advantages

There are a number of situations in which a personal loan might be preferable to other types of loans for financing a financial shortfall. Here’s an example:

  • They Can Be Put to a Wide Variety of Uses. Mortgages, auto loans, and student loans are just a few examples of specialized lending products that have limited applicability. In contrast, you are free to put your personal loan for whichever purpose you see fit.
  • The use of collateral is not required. There is often no need to put up collateral when applying for a personal loan. Because of this, they are a great option for those with no collateral to secure a loan.
  • Any Amount Is Available For Loaning. One may often borrow anywhere from $1,500 up to $100,000 with a personal loan. As a result, the amount you may borrow is far more than with a credit card, but you can still utilize the loan if you require a smaller sum.
  • The Costs Are Fair. Borrowing money using a personal loan is typically more cost-effective than using a credit card. According to the data shown in this article from Credit Karma, borrowers with a solid credit score can qualify for interest rates on loans like this as low as 5% APR. Credit cards, on the other hand, often charge at least 13% APR, and that’s for the best clients.
  • Good Credit Is Not Necessary. Even if you have bad credit, you may still be able to get a personal loan. Personal loans are available from certain companies even to those with credit ratings as low as 600. Interest rates for these debtors might be as high as 36% APR. But even at that rate, it’s far less than the interest on a payday loan, a popular choice among borrowers with poor credit.
  • You Can Take Your Time Making Payments. The fact that you often have only two weeks to repay a payday loan is another major drawback. Borrowers who are short on funds often have little choice but to immediately roll over their debt or take out another loan to cover their expenses. With a personal loan, you may spread out your payments over at least a year, making it easier to manage your money.

Personal Loan Drawbacks

Personal loans provide several advantages over other types of loans, but they aren’t the optimal choice for everyone. Some of their downsides include the following:

  • Constant Payments When using a credit card to borrow money, you have as much time as you need to pay it back. A personal loan, on the other hand, has set, on-time installments. If you fail to make these payments, the lender may confiscate your collateral if the loan is secured or file a lawsuit against you for nonpayment if the loan is unsecured.
  • Higher Interest Rates Than Other Loans. Personal loans often provide cheaper interest rates than credit cards to consumers with strong credit. For people with low credit, a personal loan might cost as much as or even more than a credit card loan. Personal loans, particularly unsecured loans, can also be more expensive than other forms of installment loans, such as home equity loans.
  • Origination Charges In addition to the interest, some personal loans include a “origination charge” to cover the cost of loan processing. This cost is normally between 1 and 6 percent of the borrowed amount. This sum must be paid in full at the time the loan is taken out, as opposed to being included in the monthly payment.
  • Prepayment Penalties. When using a credit card to borrow money, you may avoid incurring interest by paying off the entire debt as soon as you can. However, this is not necessarily the case with a personal loan. Many banks impose a prepayment penalty if you pay off your loan early in order to compensate for the lost interest.
  • Possibility of Scams. The last danger associated with obtaining a personal loan is that not every loan offer is real. Scammers provide bogus applications for personal loans in order to obtain your personal information, which they exploit to steal your identity. In other instances, you are also charged an upfront cost to initiate the loan, after which they vanish with the funds. This is a recognized advance-fee fraud.

Bottom Line

Even though personal loans can be a helpful financial tool, they aren’t always the best choice. Those with excellent credit may benefit more from a zero-interest balance transfer offer, while those with low credit may be better off applying for a new credit card and borrowing the money that way. Doing the arithmetic yourself is the only way to find out for sure.

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