Personal Loans: A Beginner’s Roadmap

Posted on October 31, 2017

Borrowing money can be intimidating, especially if it’s your first time. There are many different types of financial tools for borrowers. It can be tough to choose the right one when you don’t understand them.   

Personal loans are popular and accessible for good reasons. They’re particularly well-suited for covering unexpected or large expenditures. Here’s a roadmap to understanding personal loans and how to find the right one for you.  

Understanding Personal Loans

What are Personal Loans Used For?

Personal loans are often used to secure big-ticket purchases. This could include furniture, appliances, vacations, and household needs.   

According to national data, these are the most common ways personal loans are used:

  • 55% – Consolidate or refinance debt
  • 8% – Purchase a car
  • 7.3% – Moving expenses
  • 5% – Medical expenses

But a personal loan can help you cover the cost of a wide range of things, from a wedding or family reunion to a home repairs or other emergency situations. This is because it gives you an immediate influx of cash, with the opportunity to repay it over time.   

Personal loans are also sometimes used to pay down other debt. Credit card interest or interest on loans of other types are often higher than that on a personal loan.

Higher-interest debts carry higher interest costs. Paying them off with a personal loan can decrease the amount you pay for interest. This can help you lower your monthly payments and help you get out of debt faster.  

Do Personal Loans Require Collateral?

Personal loans don’t need collateral. This makes them an “unsecured loan.” Approval for unsecured loans is generally based on creditworthiness. Other factors also have an impact. This is because the lender has no collateral to guarantee that you’ll repay what you’ve borrowed.   

When you borrow money against collateral, the loan is secured. The lender can repossess the collateral to repay the debt. Unsecured loans are riskier for lenders. They usually carry a higher interest rate than secured loans due to the increased risk.  

Will a Personal Loan Affect My Credit?

Personal LoansHow you handle your personal loan can have a significant impact on your credit score. You can improve your credit score by making payments on-time and never missing a payment. This becomes even more important if you don’t have other personal loans on your credit report.   

Better credit improves your access to financial tools. Good credit is also essential for lower interest rates on future loans. Missing payments and paying late can hurt your credit score, and your wallet, too.   

Poor credit can block your access to personal loans. You could end up paying more due to fees, especially for late payments. Interest rates could also be so high that the loan payments are no longer reasonable.  

Deciding if a Personal Loan is Right for You

Weighing the Benefits

A personal loan is a big commitment. You’re borrowing money and paying for the privilege of doing so in the form of interest.   

You must decide whether the cost is worth the benefit that you’ll get from taking out the loan. Getting the loan may mean being able to take care of expenses. You could upgrade your belongings or make a big life event possible.  

Understanding the Responsibilities

There is more to weigh than the positive outcomes. There’s responsibility in taking out a personal loan, too. You’re obligating your future income to make those payments.   

Your budget must have enough wiggle room to fit in the new loan payment. Otherwise, you could be doing your finances (and your credit) more harm than good.   

Having a personal loan requires a certain amount of discipline. You will have access to a lump sum of cash when the loan is approved.   

It can be a thrill to have enough money to buy something expensive, but don’t let that cloud your judgement. It’s very easy to get too far into debt. This sets up a spiral of taking out loans to pay previous loans and never being debt-free.  

Exploring Your Reasons for Getting a Loan

There are many reasons you might need a personal loan. It’s important to make sure your reasons are the right ones. Personal loans are not “free money,” and must be repaid to the lender, even if there’s no collateral securing the loan.   

Failure to repay a personal loan could result in hits to your credit. You might even face lawsuits, as the lender can take action to get the loan repaid. Use personal loans responsibly; don’t commit yourself to paying back more than you can afford.   

Personal loans should never supplement your monthly spending. Using any type of loan to take care of day-to-day expenses is unsustainable. Doing so can, very quickly, lead to severe financial problems. Make a budget and stick to it.   

Document everything you spend to understand where your money goes. This will help you determine whether you can afford a loan payment. Account for monthly payments on balances that are to be paid off with the personal loan.

These amounts should be subtracted from your total monthly bills. Replace these amounts with the proposed monthly payment on your personal loan.  

Factors That Impact Personal Loan Terms

Annual Percentage Rates (APR) on Personal Loans

Your loan will have an annual percentage rate (APR). The APR is determined by several factors that are unique to each borrower.   

So, the APR on your loan may be different than the APR on a similar loan for a buyer with different qualifications. The following factors can have an impact on your loan’s APR:      

  • Your credit – Your credit report and credit score will have a large impact on your loan’s interest rate and APR. The worse your credit history or the lower your score, the higher your loan’s APR is going to be. You may be able to improve your credit by paying off old debts. Dispute incorrect items on your credit report. Avoid new lines of credit in the months preceding your application for a personal loan.
  • Loan amount – Lenders may charge somewhat higher interest rates for smaller loans. This may also apply to loans that will be repaid over a short term. This makes it possible for those loans to be worthwhile for the lender. Lenders might not otherwise have the incentive to make them available.
  • Secured or unsecured loan – Most personal loans don’t need collateral. If your credit is not good enough for an unsecured loan, you may have to offer some type of security for the loan. Unsecured loans generally have higher interest rates than secured loans. This is due to the increased risk and lack of collateral.
  • Lender type – There are several types of financial institutions that offer personal loans. These include banks, credit unions, payday lenders, and peer-to-peer lenders, among others. Some loan options are better regulated than others. Banks and credit unions are governed by strict regulations. Alternative lenders are more loosely regulated. Weigh the benefits and disadvantages of using alternative lending sources.

The APR is the average percentage of your loan that you’ll pay in interest on an annual basis. It may be listed along with the interest rate, and the lower it is, the lower your payments will likely be. Lenders may have very different annual percentage rates. Shop around for the lender that suits you best.  

Choosing The Right Lender

The lender you choose can be one of the biggest factors affecting your loan terms. Here are some of the most common types of lenders and how they may affect your loan terms.      

Credit unions

Credit unions are usually locally-based and serve the communities around them. They often offer lower interest rates and more flexible loan terms than do big banks. You have to be a member of a credit union to get a loan through them.

There may also be certain qualifying requirements to become a member. Loan decisions are usually made at the local level. Credit unions are typically more willing to work with you to get the money you need at a rate you can afford.

Banks

Banks are the most recognized financial institutions for many borrowers. Some banks may be locally-based. Most, though, are branch offices for large banking entities. Bank requirements for getting a loan may be more stringent than credit unions.

The interest rate and APR may be higher than that available at a local credit union. Not all banks offer personal loan services. Some banks need you to be an account holder before they’ll lend to you.

Payday loan services (“quick cash” providers)

Payday loans don’t need good credit. They do generally require that you have a job and be able to prove your income. This makes loans easier to get. Be ready to pay for the privilege. Payday lenders charge very high interest rates. They may also tack on excessive fees for their service.

Crowdsourced (peer-to-peer) lending

Peer-to-peer lending (P2PL) is a relatively new loan option. This type of lending relies on crowdsourced funds. The funds are then invested by making personal loans to borrowers.

This type of lending may have very different restrictions than traditional lending options. It may provide a larger loan amount than what’s typically available for personal loans.

Traditional personal loans can range from a few hundred to a few thousand dollars. P2PL may make amounts up to $35,000 or more available for borrowers. With P2PL, borrowers and lenders connect in an online environment. There, they discuss terms and come to a loan agreement. Unsecured loans are most common.

Depending on the lender and your needs, secured loans may also be available in a P2PL format. You can expect to find a variety of terms, interest rates, and loans available through P2PL. It’s up to the lender and borrower to create terms that suit them.

Your credit score will be a big factor with P2P loans. Your education and current employment status (and history) may also be considered.

Applying for Your Personal Loan

What to Expect When You Apply

Once you’ve decided to get a personal loan and chosen a lender, you’ll have to submit a loan application. The information you’ll be asked to provide may include:      

  • Legal name
  • Social Security number
  • Birthdate
  • Current address
  • Previous addresses and how long you lived there
  • Current employer information
  • Past employer information
  • Current occupation
  • Household income (gross, monthly or annual)
  • Sources of income
  • Information on existing lines of credit

You may also be asked about your credit history. You may have to disclose other bank accounts. They’ll also want to know about any outstanding debt, and if you pay your bills on time. These answers can be found through your credit report, so be honest.   

You’ll also need to know how you want funds from the loan disbursed (paid out). Disbursements can be in the form of a check made out to you or a deposit into a designated bank account. There may also be other avenues offered by your lender.  

Submit An Application Online Now

After You Submit an Application

Your approval time will vary depending on the lender and the application information. In general, you can expect to have a decision on your loan anywhere from a few days to a few weeks after you apply.   

It’s possible that you may be denied when you apply for a personal loan. If this happens, it’s important to discuss the reasons with the lender. Once you understand the causes for the denial, you can work to correct them. This will help future applications avoid the same fate.   

Upon approval, funds will be disbursed. This will happen according to the details you discussed during the application process. You’ll likely have to go to the lender and complete the loan paperwork.

This paperwork will tell you when your first payment is due. It will also include how much your payment will be. Other pertinent information should also be included.  

After the Loan is Disbursed

After getting your loan, keep your payments current. You likely won’t have a payment in the month you get your loan. Read your paperwork carefully. It will include when and where you should make your payments. Take note of late fees or other fees that could change the amount of your payment. Be aware of the fine print.   

Getting a personal loan isn’t as intimidating as it may seem. It’s easy to make mistakes if you don’t think things through, though. Remember, you’re going to have to pay that money back to the lender, even if you spend it frivolously. Personal loans come with personal responsibility, no matter the borrowed amount.

Read The Most Frequently Asked Personal Loan Questions

For more information about personal loans in the Richmond, VA, contact us at Partners Federal Financial Credit Union by calling (804) 649-2957.  

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Excludes mortgages and home equity lines of credit. A $25 fee is due at set-up for each loan. Loan must have been open for at least 6 months. Past due accounts do not qualify. One skip-a-pay allowed per calendar year (Jan-Dec).

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