Personal Loans: A Beginner’s Roadmap

Posted on August 16, 2017

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

Personal loans are popular and accessible, and there’s a good reason for that: 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 like furniture, appliances, vacations, and household needs.

They can also be useful in unexpected situations like repairing or replacing a water heater, getting medical care, or some other emergent situation. You can even use personal loans to finance life events like weddings, graduations, and family reunions.

These are all situations where a personal loan can be useful because it gives you an immediate influx of cash and the opportunity to repay it over time.

Personal loans are also sometimes used to consolidate other debt. Credit card interest or interest on loans of other types are often higher than that on a personal loan, so paying off those higher-interest debts with a personal loan can potentially decrease the total amount of interest you’ll pay, lower your overall monthly payments and help you get out of debt more quickly.

Do Personal Loans Require Collateral?

Personal loans don’t require collateral, which makes them what is considered an unsecured loan. Approval of unsecured loans are generally decided based on creditworthiness and other important factors 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 because the lender can repossess the collateral to satisfy the debt. Unsecured loans are riskier for lenders, and usually carry a higher interest rate than secured loans because of the increased risk.

Will a Personal Loan Affect My Credit?

How you handle your personal loan can have a significant impact on your credit score. Making payments on-time and never missing a payment can improve your credit score overall, especially if you don’t have other personal loans on your credit report.

Better credit means better access to financial tools and lower interest rates on future loans. Conversely, missing payments and paying late can hurt your credit score, and your wallet, too.

Not only could you end up paying late payment fees, poor credit can block your access to personal loans or make the interest rates so high that the 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. The benefits of getting the loan may include being able to take care of expenses, upgrade your belongings or make a big life event possible.

Understanding the Responsibilities

There is more to weigh than just 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 comfortably 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 in that 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, setting up a spiral of taking out loans to pay previous loans and never being debt-free.

Exploring Your Reasons for Getting a Loan

Although 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 and even lawsuits, as the lender can take action to get the loan repaid. Make sure you’re using personal loans responsibly; don’t obligate yourself to pay back more than you can afford.

Personal loans should never be used to supplement your monthly spending. Using personal loans or other types of loans to take care of day-to-day expenses is unsustainable and could lead to severe financial problems very quickly. Make a budget and stick to it.

Carefully document everything you spend to really understand where your money goes and whether or not you can afford a loan payment. If you’re planning to consolidate other debts with your personal loan, make sure to take that into account when determining your ability to repay the loan.

Factors That Impact Personal Loan Terms

Annual Percentage Rates (APR) on Personal Loans

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

Therefore, 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, disputing incorrect items on your credit report, and avoiding new lines of credit in the months preceding your application for a personal loan.
  • Loan amount – Lenders typically charge somewhat higher interest rates for smaller loans or loans that will be repaid quickly. This makes it possible for those loans to be worthwhile for the lender. Without the better return on smaller or shorter loans, lenders might not have the incentive to make them available.
  • Secured or unsecured loan – Most personal loans don’t require collateral. However, if your credit is not good enough for an unsecured loan, you may have to offer some type of security for the amount you borrow. Keep in mind that unsecured loans generally have higher interest rates than secured loans due to the increased risk and lack of collateral.
  • Lender type – There are several types of financial institutions where personal loans can be obtained. 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, while alternative lenders are more loosely regulated. It’s important to 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, so it’s a good idea to try to shop around for the one 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. However, you have to be a member of a credit union in order to get a loan through them and there may be certain qualifying requirements that must be met before you can become a member. Loan decisions are usually made locally and 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, but most are branch offices for large banking entities. Bank requirements for getting a loan may be more stringent than those offered by credit unions, and the interest rate and APR may be higher than that available at a local credit union. Keep in mind that not all banks offer personal loan services, and some of them require you to be an account holder before they’ll lend to you.
  • Payday loan services or “quick cash” providers – Payday lenders don’t require that you have good credit in order to give you a loan. However, they do generally require that you have a job and be able to prove your income. This makes loans easier to get, but be ready to pay for the privilege; payday lenders charge very high interest rates and may tack on a number of fees for their service.
  • Crowdsourced (peer-to-peer) lending – Peer-to-peer lending (P2PL) is a relatively new option for those seeking personal loans. This type of lending relies on crowdsourced funds that are then invested by making personal loans to borrowers. Be aware that this type of lending may have very different restrictions than traditional lending options, but it may provide a larger loan amount than what’s typically available for personal loans. Traditional personal loans can range anywhere from a few hundred to a few thousand dollars, whereas P2PL may make amounts up to $35,000 or more available for borrowers. With P2PL, borrowers and lenders connect in an online environment to discuss terms and come to a loan agreement. Unsecured loans are the most common, but 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, as 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, but 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, other bank accounts, whether you have 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); this can be in the form of a check made out to you, a deposit into a designated bank account, or any other method offered by your lender.

After You Submit an Application

Depending on the lender and the completeness of the information in your application, 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 so that future applications won’t meet the same fate.

If you’re approved, the funds will be disbursed according to the details you discussed with the lender when you were submitting the application. You’ll likely have to go to the lender and complete the loan paperwork, which will tell you when your first payment is due and how much your payment will be, and should also include all of the information pertinent to your loan.

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, but read your paperwork carefully to determine when and where you should make your payments. Take note of late fees or other fees that could change the amount of your payment; make sure you’re aware of the fine print.

Overall, getting a personal loan isn’t as intimidating as it may seem, but it’s easy to make mistakes if you don’t think things through. 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.

Additional resources for personal loans:

You can also apply online now or contact Partners Financial Federal Credit Union at 800-321-5617 to speak with a personal loan expert today.

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