What Is a Personal Loan?
A personal loan is an amount of money you can borrow to use for a variety of purposes. For instance, you may use a personal loan to consolidate debt, pay for home renovations, or plan a dream wedding. Personal loans can be offered by banks, credit unions, or online lenders. The money you borrow must be repaid over time, typically with interest. Some lenders may also charge fees for personal loans.1KEY TAKEAWAYS
- Personal loans are loans that can cover a number of personal expenses.
- You can find personal loans through banks, credit unions, and online lenders.
- Personal loans can be secured, meaning you need collateral to borrow money, or unsecured, with no collateral needed.
- Personal loans can vary greatly when it comes to their interest rates, fees, amounts, and repayment terms.
How a Personal Loan Works
A personal loan allows you to borrow a lump sum of money to pay for a variety of expenses and then repay those funds in regular payments, or installments, over time. For example, you might use a personal loan to cover:- Moving expenses
- Debt consolidation
- Medical bills
- Wedding expenses
- Home renovations or repairs
- Funeral costs
- Vacation costs
- Unexpected expenses
Personal loans are different from other installment loans—such as student loans, car loans, and mortgage loans—that are used to fund specific expenses like education, vehicles, or homes.
TIP Generally, you can use a personal loan for any expense. But some personal loan lenders restrict how you can use a personal loan. For example, you may not be able to get a personal loan to pay for college tuition, fees, or other expenses.
A personal loan differs from a personal line of credit in several ways. While a personal loan provides a lump sum amount with a fixed end date for repayment, a personal line of credit functions more like a credit card, offering a predetermined credit limit that can be utilized as needed. As expenditures are made, the available credit diminishes, but it can be replenished by making payments towards the credit line.
Moreover, while a personal loan has a definite repayment timeline, a personal line of credit may remain accessible indefinitely, provided the borrower maintains a favorable standing with the lender.
Regarding taxation, the Internal Revenue Service (IRS) does not classify the funds obtained through a personal loan as part of the borrower's income, thus they are not subjected to taxation. However, if the lender decides to forgive the loan, the canceled debt is considered taxable income and may be subject to taxation.
Types of Personal Loans
Personal loans come in two main categories: secured and unsecured. Secured personal loans necessitate the provision of collateral as a borrowing prerequisite. This collateral can take various forms, such as cash assets like savings accounts or certificates of deposit (CDs), or tangible assets like vehicles or boats. In the event of loan default, the lender reserves the right to seize the collateral to settle the debt.
On the other hand, unsecured personal loans do not require any collateral for borrowing. Banks, credit unions, and online lenders may extend both secured and unsecured personal loans to eligible applicants. Typically, banks perceive unsecured loans as riskier due to the absence of collateral, often resulting in higher interest rates for borrowers.
How a Personal Loan Functions
To acquire a personal loan, one must submit an application to a lender, which can include a bank, credit union, or an online personal loan provider.
Typically, the process begins with completing an application form. Subsequently, the lender assesses the application to determine whether approval is granted or denied. Upon approval, the borrower receives the loan terms, which they can either accept or decline. If accepted, the next step involves finalizing the loan paperwork.
Once the paperwork is completed, the lender disburses the loan amount, providing the borrower with the proceeds. This disbursement can occur either through a direct deposit into the borrower's bank account or via a check, depending on the lender's policies. Following the loan disbursement, the borrower is free to utilize the funds as needed. Repayment of the loan commences according to the terms outlined in the loan agreement.
Warning : Defaulting on a personal loan could cause significant damage to your credit score. You could also lose your collateral with a secured loan or risk being sued by your lender to collect the debt.
Illustration of a Personal Loan
When contemplating a personal loan, it's beneficial to grasp its potential costs. The annual percentage rate (APR) of a personal loan signifies the yearly cost of repaying the loan, factoring in both the interest rate and associated fees. The APR, in conjunction with the loan duration, dictates the total interest outlay throughout the loan's lifespan.
For instance, imagine securing a $10,000 personal loan at an APR of 7.5% over a repayment period of 24 months. With these terms, the monthly installment amounts to $450, and the cumulative interest paid over the loan's duration equals $799.90.
Now, consider the same loan amount but with altered terms. Extending the repayment period to three years with a reduced interest rate of 6%, the monthly payment decreases to $304. However, the total interest expenditure escalates to $951.90.
Analyzing these figures is crucial for determining the most suitable monthly payment or minimizing interest expenses when opting for a personal loan. Utilizing an online personal loan calculator simplifies this process, aiding in identifying the optimal payment amount and interest rate aligning with one's budget.
IMPORTANT : While certain lenders may not impose any fees on personal loans, others might apply charges such as a credit check fee, a loan origination fee, or, in the event of early repayment, a prepayment penalty. Additionally, failing to make timely payments could result in incurring a late payment fee.
Where to Locate Personal Loans
Your primary source for personal loans could be your existing bank or credit union. Your personal banker can provide guidance on the available types of personal loans and the borrowing options that align with your qualifications.
Alternatively, personal loans are widely accessible online. Numerous lenders offer personal loans through online platforms, enabling electronic applications, rapid decision-making, and, in certain cases, funding within 24 to 48 hours post-approval.
When assessing personal loans, whether online or offline, it's crucial to scrutinize the specifics. Pay particular attention to:
- Interest rates
- Fees
- Repayment terms
- Borrowing limits (both minimum and maximum)
- Collateral requirements
TIP : You have the option to access your credit report at no cost through AnnualCreditReport.com. While reviewing it, carefully examine for any inaccuracies that could potentially lower your credit score, and don't hesitate to contest them if necessary.
It's also beneficial to review the minimum qualifications necessary to be eligible for a personal loan. Lenders often have varying criteria regarding acceptable credit scores, income levels, and debt-to-income ratios for loan approval. This assessment can assist you in identifying loans that align best with your credit and financial situation.
How Do Cash Advance Loans Differ from Personal Loans?
A cash advance loan is intended to provide short-term funds, typically for emergency situations, with higher interest rates and associated fees. Conversely, personal loans generally offer longer repayment terms and lower interest rates compared to cash advance loans.
What Are the Steps to Secure Approval for a Personal Loan?
Approval requirements vary among lenders. To enhance your chances of loan approval, consider improving your credit score and financial status, which may involve reducing existing debts. If facing difficulties in securing approval, having a co-signer with a strong credit history could bolster your application.
Are There Fees Associated with Personal Loans?
Personal loans may entail fees like origination fees, which are factored into the total loan cost. Additional charges could include documentation fees or late payment fees. Given that fee structures vary among lenders, it's essential to comprehend the specific fees imposed by your chosen lender.
In Conclusion
The extensive array of personal loan options ensures there's likely a suitable offer tailored to your financial requirements. However, the abundance of choices can be overwhelming, potentially causing you to overlook optimal interest rates and loan terms. Consequently, diligent research and comparison of various lenders and loan products are vital. By dedicating time to finding the most suitable loan, you can keep monthly payments manageable while minimizing the risk of default.
