This guide to personal loans will help you learn everything about this common type of loan so that you can make an informed decision. Let’s start with the basics before we dig deeper into interest rates, fees, and all the pros and cons of personal loans.
What Is a Personal Loan?
A personal loan is a lump sum of money that you borrow from a bank, credit union or a non-banking financial company (NBFC) to use for general purposes. Personal loans usually don’t require any collateral, which means that they are typically unsecured loans.
Many lenders won’t even ask about the borrower’s purpose for getting a personal loan, while others will limit your possibilities, that is, restrict what you do with the received funds. In most cases, your lender won’t keep track of their use.
When you need cash for some specific purpose, these loans can be a very good idea. They come with fixed interest rates, a fixed repayment period, and fixed equated monthly installments (EMI).
This means that you need to provide the same amount of money each month for a specific period of time until you pay back what you owe, and your interest rate won’t change during the entire loan term.
Once the repayment period is over, and you’ve paid back your loan in full, your lender will simply close your account. In case you need additional money, you would have to get another loan.
Common Uses of Personal Loans
As you already know, you can use a personal loan for an array of different purposes. The options are almost infinite, as you can use it to cover any larger personal expenses you need.
You can use it for purchasing a home or a car, renovating your home, paying for college, funding a wedding, paying for a family vacation, buying a PC or other cutting-edge tech device, covering unexpected medical expenses, or any other emergencies.
You can also use it for debt consolidation, such as paying off credit cards or any other debts you may have. Getting a personal debt consolidation loan means combining all your debts into a single loan. You would get a lower interest rate on all your debts, and you would need to provide fixed monthly payments for that one combined loan.
What Are Types of Personal Loans
There are two types of personal loans to choose from:
- Unsecured personal loans
- Secured personal loans.
Unsecured Personal Loan
Unsecured personal loans are the most common types of personal loans. Unsecured means that they require no collateral, which means that the lender has no valuable asset to fall back on if you happen to default on your loan.
This is exactly why personal loans are a bit difficult to get approved for, simply because they carry more risk for the lender. Every lender needs a guarantee that you will pay off your loan on time and in full. This is why they check your credit score and income level so that they can determine your repayment capacity.
If you do happen to default on an unsecured loan, and there’s no collateral for you to forfeit, the lender may take other actions to collect your debt. They may file a lawsuit or seek help from debt collectors. It goes without saying that they would report your loan default to the major credit bureaus, which would be devastating to your credit score.
Secured Personal Loan
On the other hand, secured personal loans are backed by collateral. Collateral can be your home, car, savings account, or any other valuable asset that you pledge as security for repaying your loan. You put up a particular asset as collateral to provide a guarantee that you will pay back what you owe on time and in full. Otherwise, the lender has the right to seize the asset.
Interest Rates and Fees
Interest rates are usually higher with personal loans. That is, they are higher when it comes to unsecured personal loans.
Whatever type of personal loan you apply for, your interest rate will depend on several factors. It will be based on your credit score, income level, the amount of money you want to borrow, the tenure (repayment period) you choose, whether you have any unconsolidated debt, and other factors.
Depending on the lender, and all these other factors, interest rates for personal loans usually range between 5% and 36%. The better your credit score, the lower the interest rate you will get. The longer tenure you choose, the higher your interest rate will be.
Whatever the case, you will get a fixed interest rate. All your monthly payments during the entire life of the loan will be equal.
Other Fees on Personal Loan
When it comes to other fees for taking out a personal loan, they depend entirely on the lender. Some lenders may charge you origination fees for applying for a loan. They include the cost of all the paperwork necessary to process and set up a loan.
Origination fees usually range from about 1% to 8% of the loan amount, depending on the lender, your credit score, loan amount, tenure, the purpose of your loan, whether you apply with a cosigner, and other factors.
Other lenders may also charge you a prepayment penalty if you happen to pay off your loan before its repayment term is over. This is because early repayment prevents the lender from acquiring the interest that you would have provided if you had continued making payments for a longer period of time.
Personal Loan Repayment Period
Just as you will get a fixed interest rate for your personal loan, you will also get a fixed schedule for repaying your loan.
You can choose your own repayment period or tenure, usually ranging from 12 to 60 months (12, 24, 36, 48, or 60). The longer repayment period you choose, the lower your monthly payments will be, but your interest rate will be higher.
In contrast, a shorter repayment period means higher monthly installments, but also a lower interest rate.
If you set a longer tenure, you may limit your options for potential future loans or credit cards. However, setting a longer repayment period shows that you have a healthy repayment capacity. It shows that you can afford to pay off the loan with a higher interest rate. It improves your eligibility and enables you to get approved for the loan faster.
However, if you go down this path, make sure you can actually afford it. Make sure you can provide on-time, full payments every month for the entire life of the loan.