What Is Personal Loans
Personal loans are a type of credit that you can use for personal purposes like renovating your home, repaying high-interest debt, etc. As they come with fixed high-interest rates and with a schedule of repayment, you are aware of the exact amount you need to pay each month and when the last date on which your debt payment will be made in full.
Taking debt is a serious responsibility below. Some of the suggestions will guide how to take and how personal loans work so that you don't you can avoid any kind of mistake while taking the burden of additional debt.
How does a Personal loan work?
When you borrow a precise amount of money at fixed interest rates for a particular amount of time for personal use, it's known as a personal loan. You repay the amount in parts every month until your debt is fully paid.
The terms of a personal loan vary depending upon the person's financial situation and the moneylender. Depending upon the lender, the amount also varies. As per the terms for repayment in the long term, it ranges from one year to five years, and it can also go up to fifteen years if the loan has been taken for the purpose of renovation of the home. A personal loan is usually unsecured debt meaning that they are not secured by underlying investment like a car or a house; hence, for this reason, they come with a high-interest rate compared to other types of loan like a house loan or car loan.
To get a sense of the personal loan interest rates, keep an eye on the annual percentage rate. The interest and other costs are included in it; it also might include the origination fees. Origination fees are the loan processing charges that range from 1% to 8% of the loan amount. You might get some of the lenders who don't charge the originating fees on the loans.
Pros and Cons of Personal Loans
Like any type of loan, there are different pros and cons of personal loans, and they are mentioned below for your better understanding.
Pros
- The greatest benefit is that the personal loan interest rates are mostly cheaper than credit cards' interest rates. Though the interest rates have gone higher in recent times, it is still a good option to consolidate high-interest credit card debts, especially if the credit score is high. Check the average annual percentage rate also before taking the personal loan.
- The time frame to access the fund from loan companies is very small. Depending upon the lender, you can get the fund within one to two days.
- As per the personal loan terms, the interest rates and repayment dates are fixed; you don't have to worry about any kind of increase in the interest rates. It helps you to pre-plan the monthly budget.
Cons
- The disadvantage of a personal loan is that you can get addicted to overspending since personal loans can be used for any purpose. You might borrow the amount that can be over the capacity of your repayment.
- Some of the other loan products' interest rates might be lesser than that of the personal loan. For example, if you possess equity in your home and have a good credit score, you might be able to get a loan at a better interest rate by home equity loan or line of credit.
- There is always likelihood that you might damage your credit score if you cannot repay the amount on a timely basis. Some of the lenders will work with you if your financial situation has worsened; they might also assist if you have lost your job. But your credit score will get hampered if you are unable to make the payment.
What may you need to qualify for a personal loan?
When you apply for a personal loan, the lender sets certain criteria and the documents required based on which they will be able to decide the interest rate and the amount that they can disperse to you. Following are the parameters.
- Every lender will go through your credit score; hence you must have a good or excellent credit score. If your credit score is 640 or below, it will be difficult for you to obtain personal loans with better interest rates. Some of the lenders might work with you, but the interest rate will be too high. If you have a credit score around 670 and above, you will have many borrowers’ options. If you have a credit score of about 740, you will qualify for the best personal loan interest rates and terms.
- If you have a high debt to income ratio, then the lender might be slightly hesitant to loan the money to you. The ratio is derived by totaling your monthly recurring debt and dividing it by the monthly gross income. The lenders also look at your DTI ratio, which should be 36% or less. Even if you have a high DTI ratio, but your credit score meets the lender's criteria, and you have a good income and repayment history, the lenders will work with you.
- Even if you have a bad credit score, some of the loan companies might work, but they will require a cosigner or collateral to help you qualify for a personal loan.
How to pick the best personal loan?
Below, some of the tips mentioned that would help you identify the personal loan rates and terms that are best suited for you.
- Browse through various lenders who provide personal loans, gather information, and compare the interest rates and loan terms that they are providing.
- Always read the contract thoroughly, including the monthly payment amount, interest rates, and fee aspects.
- Before finalizing on any lender, read a review on their companies; it will help you to evaluate the quality of each lender and what experience might suit you.
Common use of personal loan
Personal loans can be utilized for various purposes and reasons by the borrowers. Some of them are mentioned below.
- Debt consolidation – If you have various kinds of debts, you can take a personal loan to repay all of them. This helps you to streamline the payment and at a lower interest rate.
- Credit Card refinancing – The interest rates of the personal loan compared to credit cards are less. Still, you have to check that you actually save the money after considering the loan's interest rate, processing fee, and repayment terms.
- Home renovation – Some use the loan to improve the home's living condition and are not qualify for a home equity loan.
- Investing in small business – If you start a small business and haven't started earning money, it may be difficult to qualify for a business loan. A personal loan can help you to kick start your business.
