A Beginners Guide To Personal Loans

by Enid Kathambi, Money Columnist


Published in Money and Finance on 17th February, 2020


Personal savings in the US has drastically reduced over the years, from 10.4% in 1960 to 7.6% in December 2019.

Yeah, that is quite a drastic drop, and a true reflection of the hard it is to get by financially these days. With this, most people only have the option of seeking credit from financial institutions.

This is where personal loans come in. What are personal loans?; how can you get one? What are the financial implications? Well, you have come to the right place, as we are about to give you a beginner's guide to personal loans.

personal loan

What is a personal loan?

A personal loan is a credit extended to you by a financial institution for your personal use. It comes with fixed terms of repayments and interest rates. Also, a personal loan does not have a fixed asset attached to it, unlike loans like mortgages and auto loans.

Secured vs. unsecured personal loans

A secured personal loan is a loan you borrow with collateral like your home attached. Secured loans are mostly for large borrowings, and financial institutions use the collateral to recoup their losses in case you default on the loan.

Additionally, the interest rates for secured loans are lower, thanks to the collateral. However, in case you default, be prepared to lose your property.

Unsecured loans, on the other hand, do not have assets as collateral attached. As such, their interest rates are quite high and strict lending limits. The good news is that unsecured loans give you a better negotiating position in case you default.

How to use a personal loan

There are many uses for personal loans, and if you use online lenders like Freedom Plus or Upstart, among others, you get to choose why you need the loan. But, most personal loans cover:

  • Medical expenses - medical bills can take a toll on anyone, even if you have an insurance cover. Financial institutions are making it easy for you to get such trying times by extending a personal loan for medical expenses.
  • Home improvement - does your home feel like it needs some facelift? Well, personal loans are making it easy for you to pimp your home at once, rather than doing it bit by bit every payday.
  • Debt consolidation - if you have a plethora of loans with many lenders, you can consolidate them into one through a personal loan. This makes it easy for your financial planning since you have one loan to repay and a single set of interest rate payments. Also, you might get a lower interest rate for the loans with a consolidation.
  • Emergencies - an unexpected turn of events crop up, and you might not be in a position to handle it financially. Now, you can rest easy knowing a personal loan can help you get through emergencies in case you have no money at the moment.
  • Travel and vacation - yes, you can travel to your favorite destination even if you are broke to afford it at the moment.
  • Education - you can also get a personal loan for your education.
  • Wedding - you read that right, weddings! Are you and your partner trying to throw a fancy wedding? Are your finances getting in the way? Well, you can get a personal loan to finance your dream wedding.
personal loan

Personal loan vocabulary

Here are some of the key terms you will come across as you shop for a personal loan:

  • APR - it stands for Annual Percentage Rate. APR is the yearly finance charge you pay to the lender. It includes the interest rate and any other fees. In case the loan has no additional fees, the APR will be the interest rate of the loan.
  • Interest rate - it is the extra amount you pay back to the lender in addition to what you borrowed. If you borrow $2,000 and you pay back $2,300, the 3xtra $300 is the interest payment, if there are no other fees on loan.
  • Payment terms - these include all the information related to the loan and the repayment. Your personal loan repayment terms include interest rate, fees, repayment period, and the minimum repayment amount.
  • Prepayment penalties - in case you want to repay your loan in full before the end of the payment period, then be ready to pay the penalty. However, not all lenders have prepayment penalties, but it is advisable to confirm with your lender before you take the loan.
  • Borrowing limits - a borrowing limit will include the minimum and the maximum amount a lender is willing to lend. Borrowing limits usually depend on one's credit history, your income to debt ratio, your source of income, and the reason for the loan.

Apart from the above, it is wise to consider other terms and conditions of the lender you are using. Some lenders have additional fees like a service fee or an origination fee. These additional fees increase the finance charge of your loan, so be keen on them.

What lenders consider

When applying for a personal loan, both traditional and online lenders will ask for a myriad of information before deciding your borrowing limit, repayment period, and applicable APR.

loans

Mostly, you will need to provide the below information:

  • Credit score - lenders want to know your credit history to see whether you are financially responsible or not. A higher credit score puts you in a better position with lenders, which makes it easy for you to get a better rate and better repayment terms. If your credit score is 500 and another borrower has a credit score of 800, then they will get better terms than you.
  • Source of income - lenders often ask about your source of income. If you are employed, you might have to provide the lender with your pay stubs or other information regarding your employment. You will also have to provide your Social Security number. If you have a steady source of income, you may qualify for a higher limit and a better APR compared to a borrower without a steady stream of income.
  • Collateral - if you are applying for a secured personal loan, then your lender will need you to provide a guarantee for the loan. If you are giving out your asset as collateral, then you will hand over the deed.
  • Cosigner's information - if you have a bad credit score, some lenders might ask for a cosigner for you to get the loan. Your cosigner is responsible for the loan in case you default. So, be careful not to burn bridges with your loved one when they cosign for you, and you decide to default.

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