Personal loan is a very good option to get rid of financial problems. It can be used as a credit card alternative. Credit card interest rates tend to be higher than personal loans. So many people take out personal loans to relieve the burden of credit cards.
Personal loans are good option for those who have a very good credit score. Personal loans are not convenient for those who do not have a good credit score.
What is a personal loan?
When a person takes a loan from a bank, credit union or online lender to meet his personal needs, it is called a personal loan. A person can take a personal loan for various purposes. A person can borrow to pay for school fees or medical expenses, buy a car, consolidate high-interest debt, home improvements, fund a big purchase.
Personal loans are usually unsecured. Unsecured means that a borrower does not have to use any collateral to get this loan. Personal loans are usually $1k to $50k and the repayment term is 1 to 10 years. We know that Interest rates on personal loans are fixed so borrowers have to pay fixed-amount installments over a set period of time until the debt is completely repaid.
Common Loan Terms
The amount you borrow from a lender is called the principal. Suppose you borrow $20,000 from a lender. Then this $20,000 will be called Principal. Interest is calculated on the basis of the principal. The more installments you pay, the more your principal will decrease.
Interest is the cost of borrowing or lender charges on borrower for the use of its money. Interest can also be termed as finance charge.
Interest calculation formula: Interest rate/ number of payment × loan principal = Interest
APR stands for annual percentage rate that refers to the annual rate of interest charged to borrowers for taking out loan. Many people think APR and interest rates are the same. But there is a difference between the two. Fees are not added to determine interest rates but fees are added to determine APR.
Term is an important factor in any loan. This will let you know how many months or years you will get to repay the loan. When you take out loan the lender will inform you about the term. You have to pay the installment within this period. If borrower fails to repay all the dues within the stipulated time, he may face penalty.
Borrowers have to pay installments to the lender every month during the term. Monthly payment includes
a portion of the principal of the amount you owe and a portion of the total interest.
Suppose you borrowed $5,000 at an interest rate (APR) of 4.5% which must be repaid within 60 months (5 years). Then you will need to pay $93.22 every month for 5 years to pay off the debt. Of this, principal is $74.47 and interest is $18.75.
Secured and Unsecured loan
When you use collateral to get a loan, it is called a secured loan. Unsecured loan is when you don’t have to put up any collateral for borrowing loan. Personal loans are usually unsecured. Basically you need a good credit score or cosigner to get a personal loan.
How do Personal Loans Work
Personal loans can be secured or unsecured. If it is secured, the borrower has to put house, car or any other asset as collateral. If borrower fails to repay the loan, the lender may confiscate his assets.
And if it is unsecured then there is no need to use any collateral to get a loan. If you fail to repay the loan you will face financial penalty but the lender can’t garnish any of your assets. Personal loans are usually unsecured.
After you apply for a personal loan, if the application is approved, the loan amount will be credited directly to your bank. You will get a fixed term to repay the loan. The loan repayment period is usually 1 to 10 years. The interest rates of personal loans are fixed. However, these matters will depend on the decision of your lender. For example, Goldman Sachs offers loans with terms from 3 to 6 years and SoFi offers from 3 to 7 years.
Personal loans can be used for a variety of purposes. You can use the loan as per your need.
You can cover any emergency expenses if you want, you can refinance to reduce the interest rate of credit card, you can use it to buy a car or any property.
How much you borrow will depend on your financial needs. If you can’t figure out your financial needs then you can take out a personal line of credit. A line of credit (LOC) is a predetermined credit limit from this you can take out loan any time. In this case the interest rate becomes variable. You only have to pay the amount of money you borrow plus interest.
How to Apply for a Personal Loan
To get a personal loan, you first need to find a lender. Once you find the lender you have to go through the application process. The application must include your personal information, financial status, Social Security number and details of the loan you want to get.
After applying, if the lender is satisfied with your application, you will get a loan. But before approving the loan, they will check your credit report and debt-to-income ratio very well.
Depending on this report you will get a loan or not. If your credit score is very good then you will get loan very easily. Your interest rate will also be slightly lower. And if the credit score is low then the chances of getting a loan will be less. If you get a loan, your interest rate will be higher.
FICO credit scores usually range from 300 to 850. If one’s score is 690 or higher then it is called good or excellent credit scores. He gets a loan very easily. And to get a loan, a borrower needs at least 610 to 640 score. However, it is important to note that each lender will verify your credit score according to them. So try to find out how much credit score is needed to get a personal loan by contacting the lender.
Lender may charge some fees some fees to process a personal loan. You will need to pay the origination fee for your application process and loan disburses. Again if you want to repay the loan in full before the due date then you have to pay prepayment penalty fees. Since not all lenders charge such fees, you should ask upfront about any fees or penalties tied to the loan.
Pros and cons of a personal loan
Every loan has some benefits and drawbacks. Personal loans also have some advantages and disadvantages. You should consider these before taking out personal loans.
- Personal debt is called unsecured debt. If you do not have to use collateral to get a loan, it is called an unsecured loan. Since you do not have to put car, house or any other assets as collateral, you can apply for the loan without any hassle. If you fail to repay the loan, you will face financial penalties but will not lose any assets.
- Interest rates on personal loans are much lower than on credit cards. As of February 2021, the average interest rate on personal loans is 11.84 percent while the average credit card interest rate was 16.04 percent. So it is a great advantage to the personal loan borrower.
- Since the interest on personal loan is fixed, it is very easy to manage. Therefore, the monthly payment is also fixed so that a borrower can easily prepare for the repayment of the loan.
- Another great advantage of personal loan is that you can use it for different needs. If you wish, you will be able to buy a house or a car, pay for your education or medical expenses, and consolidate your debt.
- If your credit score is not good then the interest rate on personal loan may be higher than other options.
- Personal debt fees and penalties are not transparent. These are more or less at the discretion of the lender. For example, some lenders charge 1 to 6 percent origination fees to complete the loan process. Again, many lenders may impose prepayment penalties if borrower pays the balance off before the end of the term.
- It is often seen that the loan is not available as per the need of the borrower.
- Personal loans tend to have a higher monthly payment than credit cards. There is no deadline for credit card repayment but there is deadline for paying personal loans balance off.
When should I get a personal loan?
People take out personal loans for a variety of reasons, including debt consolidation, emergency expenses, tuition or medical expenses.
When you apply for a personal loan will depend on your financial needs. You can apply for a personal loan when you think personal loan is less expensive than credit card loan and you are able to pay the monthly installment.
How much can I borrow on a personal loan?
The amount of personal loan you can get depends on the lender you choose. Personal debt usually ranges from $1,000 to $50,000. However, some lenders offer personal loans as high as $100,000. Such as LightStream and SoFi.
Is it wise to get a personal loan?
Personal loans are good for those who have a excellent credit score. If you have a bad credit score, it is better not to take out a personal loan. This is because those with a bad credit score tend to have higher interest rates on their loans. Again there are many lenders who do not want to lend to the person who has bad credit score.