Not too long ago, personal loans were considered an absolute last solution to solve pressing money matters. Now, they have become the fastest-growing consumer lending in America, growing like a weed that cannot be tamed. There are currently 21.1 million outstanding personal loans in the US, with an outstanding debt of about $143 billion.
How do personal loans work? The most alluring thing about personal loans is that they are unsecured and flexible enough for almost anyone. The loan amount and interest rates always depend on a person’s credit score, but most people view them as a fast solution to pay for unexpected expenses, consolidate debt, make home improvements, and a lot more.
The thing is, though, that they may not always be the perfect solution for everyone. Just like any other kind of loan, personal loans also come with their upsides and downsides, and it’s imperative for you to understand what you’re getting into if you plan to get one.
In this guide, we’ll look at how personal loans work and the top five things you need to be aware of before you get one.
How Do Personal Loans Work?
Personal loans are like an installment loan that allows you to borrow a fixed amount of money and pay it back with interest on a monthly basis. Loan terms can range anywhere between one to five years, though some lenders can offer up to 7 years, depending on other terms. Once you pay your loan amount, plus interest rates in full, your account is closed.
Types of Personal Loans
There are two types of personal loans, which are unsecured and secured.
Unsecured personal loans are the most popular, and you don’t need collateral to back them up. Borrowers that don’t pass the personal loan qualifications for this or those that want lower interests can get secured personal loans instead. This way, if they’re unable to pay their loan in full, the lender will have something to claim.
Top 5 Things to Know About Personal Loans
Whether you need a personal loan for a home improvement project, debt consolidation, or a brand new car, there are some things you must understand first. These tips will help you make an informed decision about whether to get the loan or not.
1. Understand Personal Loan Qualifications
Qualifying for personal loans is usually easy for most people, so you can check your eligibility with banks, credit unions, private lenders, or building society. For any lender or lending institution to offer you a personal loan, they must first assess your credibility and your financial history for reassurance that you’ll pay them back. They will check your credit score and possibly report it with credit reference agencies to get an idea of your borrowing history.
If you have a bad credit score, chances are, you’ll either get very high-interest rates, or you’ll be denied the loan. If you have a good score, however, you stand to get a larger amount if you want and lower interest rates as well.
2. Personal Loans Have Fixed Interest Rates
The interest rates of your personal loan will vary depending on the amount you need and your credit score. However, personal loans come with fixed interest rates, which means the rate will remain unchanged over the term of the loan. This means you know exactly what to budget for, and there won’t be any surprises later on.
The difference with variable loan rates is that they change a lot. Usually, they start out small, but they can fluctuate to reflect the market. If you’d like a loan with a fixed interest rate, then a personal loan may work for you.
3. Some Personal Loans May Have Fees
Personal loan requirements and qualifications vary, but the first step is qualifying with a reasonable interest rate. It’s vital that you read the fine print down to the last detail before making final decisions. You may encounter lenders that tack origination fees or charge prepayment penalties, and you may have to pay a loan-processing fee.
Prepayment charges apply when you repay your loan too fast or ahead of schedule. Some lenders don’t do this, but most of them do, so make sure you understand all the terms stipulated to avoid such fees.
4. Personal Loans Have Many Uses
The beauty of personal loans is that you can use them for pretty much anything you want. However, this is not always a good idea. For instance, taking out a few thousand dollars for a short vacation may not be worth it, depending on the interest rates you’ll pay in the end.
Personal loans are not the best for people looking to subsidize their lifestyles. However, there are many other situations that justify getting a personal loan, such as a financial emergency like unexpected medical bills, unemployment, and unexpected car repairs.
Without enough personal savings to cover these expenses, it may be feasible to get a personal loan. Debt consolidation may work as well, but you need to be careful about how you go about managing your new debt.
5. Personal Loans Are Not Long Term Solutions
A personal loan should be a short term and not a long-term solution for your needs. It’s advisable to get the money you need for complex or unexpected financial situations. Otherwise, they could be too much to handle due to their high-interest rates if used frivolously.
Besides, the repayment period may be short, and there are certain risks involved. For instance, failure to pay or honor the agreement may lead to a lawsuit, which will potentially lead to fines and penalties.
How Do Personal Loans Work? Everything You Need to Know
How do personal loans work? This is everything you need to know and understand so you can make an informed decision about getting one. It’s imperative for you to understand all the terms of the loan before you sign anything to avoid problems later on.
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