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What is a personal loan?
A personal loan is a type of funding offering cash upfront and repaid in monthly installments. This means that you, as the borrower, borrow a fixed amount of cash from a bank or a lender in which you must commit to repaying the loan on a fixed schedule.
A typical repayment time frame ranges from 18 to 84 months, so making sure that taking out a personal loan is doable for you is crucial.
What types of personal loans are there?
There are two different types of personal loans:
- Secured personal loans
- Unsecured personal loans
Secured personal loans
A secured personal loan is backed by collateral. Collateral usually comes from savings accounts, CDs, real estate, or personally owned items. When you ensure a lender with collateral, they are more inclined to lend out bigger sums of cash at lower interest rates. With collateral, you allow the lender the right to claim these items if you cannot repay the loan.
Unsecured personal loans
An unsecured personal loan is not backed by collateral. Instead, you may undergo a more rigorous application process. The lender will decide if you qualify for the personal loan based on your credit history. If you do not qualify for the unsecured loan or want a lower interest rate, the lender may opt to give you a secured personal loan instead.
What can a personal loan be used for?
You can use a personal loan for almost any reason. There are many reasons someone would want to take out a personal loan. Some of the most popular reasons are:
- Consolidating high-interest debt
- Home improvement
- Big purchases
Consolidating high-interest debt
You can use a personal loan to consolidate debt with very high-interest rates, like credit card debt, car loan debt, student loans, etc. When you consolidate the debt into a personal loan, you can combine all high-interest debt into one single monthly payment and sometimes at a lower interest rate. This can allow you to pay off that debt in a smaller time frame.
You can use a personal loan for a home improvement project. This would be a good idea, especially if the work will increase your home’s value. Doing this can save the usage of your home’s equity as well.
You can also use a personal loan to make a big purchase that you do not have the money for upfront. Sometimes, taking out a personal loan to cover these purchases is a better option than opening a credit card in which you need to repay the entirety of the purchase with interest by the next month.
How can I get a personal loan?
Getting a personal loan is not a hard process. The first step would be checking in on your credit score. With an idea of your credit history before applying for a personal loan, you have time to fix any issues that might pose a problem or prolong your approval time.
You then need to figure out how much money you need to borrow. There are free estimate calculators online where you can input your credit score and the amount of money you wish to borrow.
It will calculate and provide an estimated monthly installment figure. With this tool, you can also do some pre-shopping for some lenders that are most likely to approve you for a loan and their potential interest rate.
In short, you can easily get a personal loan offer from an online lender with a simple application process.
Picking the best personal loan
Many banks and lenders provide the option for a personal loan, as well as credit unions, consumer finance companies, online lenders, and peer-to-peer lenders.
The internet has made it easy for individuals to research online lenders. If you are skeptical about sharing your personal information with the internet, you can check out the Consumer Financial Protection Bureau or the Better Business Bureau.
When picking the best personal loan for you, these are the things you need to consider:
- Origination fee
- Loan term
- Repayment fees
Annual Percentage Rate (APR)
The annual percentage rate is how much it will cost to borrow money, including the interest rate and fees. The APR rate can make or break your decision to take out a personal loan because it can tremendously increase the amount you are paying for the loan in the end. Usually, APR rates will range from 5% to 36% and depend on your credit score.
This is a fee that lenders charge for the loan that includes processing costs. Be sure to know how much the origination fee is before deciding to take out the loan. This can range from 1%- 6% of the loan amount.
“Loan term” refers to the period you will repay the original amount plus interest. Usually, the loan term is between 18-84 months with fixed monthly payments. It is important to note that the longer the loan term, the more interest you could pay in the long run.
Some lenders charge a penalty if you pay the loan earlier than the agreed term. Lenders typically tag this fee because they will miss out on interest money that they would have otherwise earned for the life of the loan.
These are all critical factors to consider before applying for a personal loan.
Applying for a personal loan
Applying for a personal loan is a significant decision. Before applying, it is a good idea to compare the application requirements of different banks and lenders. After checking in on your credit score, getting prequalified is the next step. This is a process in which the lender reviews your personal information and gives you an estimated loan amount and interest rate for which you may qualify.
Getting prequalified does not usually affect your credit score and does not always mean you will get approved for the application. The pre-qualification is used to help you understand if you are likely to become approved and the potential loan terms for which you may qualify.
Usually, a prequalification assessment is free, but some lenders charge an actual application fee when an official application is submitted. It is essential to ask about all costs upfront, so you aren’t caught off guard.
After the prequalification, you can decide if you want to proceed with the official personal loan application. The formal application usually includes:
- The amount you want to borrow
- How you will use the money
- Annual combined income (of yourself and the co-signer)
- Employment status
- Credit score/ credit history
- Social security number
Once you have submitted this information in your formal personal loan application, your credit gets checked with a hard inquiry.
How can a personal loan affect your credit?
Once a personal loan prequalification is performed, it results in a soft to no impact on your credit. Once the official application is submitted, you must know that your credit is now subject to a hard inquiry and can have a short-term negative effect on your credit report.
Remember that repaying your loan installments on time and in full positively affects your credit score.
As well, choosing to take out a personal loan to consolidate your high-interest debt can greatly increase your credit score.
Finalizing your personal loan
Once you have gone through all the steps and submitted your personal loan application and required documents, the lender will review it thoroughly and decide if you are approved.
Some major factors that are factored into this approval decision are if you can repay this loan based on your income and credit history. Lenders will be more inclined to approve you if you have a strong credit history, including making payments on your debt on time.
Once approved, you are provided with a detailed document that states the approved loan amount, loan terms, APR, fees, and your fixed monthly payment.
Reading through this document thoroughly to understand what you are signing is important. After you have agreed and signed the dotted line, your loan amount will be deposited into your account and cleared. This approval and deposit period can take as little as one day to one week.
The bottom line
Deciding to take a personal loan is a big decision that requires research and care. It is essential to know all the ins and outs of taking a personal loan before jumping into it and understanding how it affects your credit and monthly budget.
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