Full Guide to Personal Loans
Personal loans are one of the most versatile financial products in the industry. Traditional lenders such as banks and large financial institutions issue loans of varied amounts, peer-to-peer lending and micro loan sites finance very small day-to-day operations and the online personal loan industry is a booming arena. Suffice it to say, there are many different types of personal loans out there, each with its own nuances. If you’re thinking about taking out a personal loan, take the time to understand what’s available to ensure you make the best decisions for your specific financial needs.
Personal Loan Uses
Personal loans do not necessarily have a defined use. Lenders will issue loans for large one-time expenses such as:
- engagement rings
- home renovations
- or even medical expenses
It’s important that borrowers do not overextend themselves, since these are not revenue generating borrowing purposes. These loans should only be taken out if a challenging set of circumstances presents itself.
Some possible revenue generating reasons for applying for a personal loan include: auto purchase, home purchase, debt consolidation or starting a business. To make a successful loan decision, the benefits to the borrower must outweigh the cost of taking on debt.
Understanding Personal Loan Rates
Understanding interest rates is critical for borrowers to fully realize the impact of a loan and how much it will cost them in the end. Put simply, the interest rate is the rate a lender charges a borrower for lending. The interest rate that you are charged will depend in part on your credit rating, so do not go in assuming you will be offered the bank’s advertised rate. Some personal loans have variable interest rates, meaning they are not fixed and can go up or down with the market.
Interest rates are important in two ways. First, they incentivize lenders to issue loans, which is necessary for stimulating economic growth. Secondly, loan issuers take on the default risk of not getting the money they lent back, and need to be compensated for that risk.
What is APR?
The next figure that a borrower needs to fully understand is the APR, or annual percentage rate. This is the amount that the loan is actually going to cost you - interest charges along with additional fees. While some lenders may issue a loan at a lower interest rate than others, the actual APR may be higher if they charge more fees, so paying attention to the bottom line is in the borrower’s best interest. Rates for personal loans are generally calculated using the borrowing amount and the borrower’s personal credit rating, but each issuer has their own unique credit rating formula. Most personal loan issuers give fixed rates between 5.99% APR – 39.99% APR, but shop around because all lenders are different.
Secured and Unsecured Lending
Lenders will issue personal loans at lower rates if a loan is secured by a lien on an asset. This is known as a secured loan, with the alternative being an unsecured loan.
- A secured loan allows the lender to take ownership of the asset if the borrower defaults, and can be a more affordable option due to the decreased default risk.
- A lender will charge a higher rate on an unsecured loan because of the added risk. Being delinquent on an unsecured loan will harm a borrower’s credit, which will make borrowing in the future more expensive. In some cases, a borrower may have to declare bankruptcy if their debt becomes unmanageable. Credit can be repaired over time, but declaring bankruptcy will permanently affect a borrower’s ability to take on debt in the future.
Short Term vs. Long Term Loans
A crucial component of a loan is the term length of the repayment structure. Loans are granted in either short-term or long-term structures, generally ranging from as short as six months to as long as seven years.
Some companies offer several different term lengths while others will only offer one or two. For example, these are the best long term personal loan providers. It is important that a customer choose a loan with a repayment schedule that matches their income and expenses so they do not become delinquent.
The 3 Most Common Types of Personal Loan
Loan types vary in purpose, loan amount, repayment terms and, of course, the interest rate on the loan. The following are some of the more common personal loans types:
- Installment Loan
Just as the name implies, installment loans are paid back at set intervals over a period, for example as once-a-month payments. The borrower receives a sum of money upfront, which is then repaid over the period of the loan. These repayments are not set in stone, as they can occasionally fluctuate according to interest rate changes or specific loan terms. The longer the repayment period of an installment loan, the lower the payments and the higher the interest rate. There may be a few options of loan periods available, so take the payments and interest rates into account when choosing the best installment loan for you.
- Revolving Loan
With a revolving loan, the amount borrowed varies, meaning that your payments will vary, too. You can either pay the balance owed in full or you can pay only a portion of it. The most common type of revolving loan is a credit card.
- Line of Credit
A line of credit is a form of revolving loan that is usually associated with home equity loans. Once approved, you’ll be allocated a line of credit and be allowed to borrow up to that amount. You can either borrow all the money upfront, or withdraw it on an as-needed basis. Payments have similar flexibility – you can repay the loan over any period.
There is a limitation to a line of credit that you won’t come across with credit cards – a time interval when you will no longer be able to draw from your credit line, and will need to start making repayments for a certain period.
Do I Need Good Credit to Qualify for a Personal Loan?
A borrower's financial situation will determine the loan amount they can qualify for and the interest rate they will have to pay. While banks will generally require a high credit score (at least 700), particularly for an unsecured loan, online lenders and peer-to-peer lenders tend to be more forgiving where credit score is concerned.
Some online lenders will give loans to those with credit scores below 600. However, the lower a borrower's credit score is, the lower the amount they can qualify for will be and the higher the interest rate they will pay.
To qualify for a larger amount, in the $10,000 and up range, a credit score of at least 660 will generally be required. In addition, to secure such a loan, the borrower will have to provide proof of gainful employment.
How to Apply for a Personal Loan
Applying for a personal loan from an online lender generally takes a matter of minutes. Online loan providers request the borrower’s personal information, such as address and date of birth, as well as their basic financial information, such as monthly income, employer and current outstanding debts.
Depending on the loan provider, there may be another more rigorous qualification process after the initial online application is approved. Lenders will check a prospective borrower’s credit to see if they meet the minimum standard to apply for a loan. It is advised to be sure that the loan provider does only a “soft credit pull.” When a lender checks your credit it can negatively affect your credit score. A soft credit pull is a way of checking credit without damaging a borrower’s score.
Online loan aggregators, or peer to peer loan marketplaces, will provide the borrower with a list of lenders based on the information provided on their application. This allows the borrower to choose the loan with the best terms from a list of lenders competing for their business.
How to Choose the Right Lender for Your Needs
When taking a loan, a borrower should be seeking the best possible terms that allow them to pay the lowest amount over the life of the loan. However, the borrower may have to compromise if they have a less than stellar credit score, they need the loan quickly or they cannot provide collateral for a secured loan.
Online lenders, loan aggregators and peer to peer lending platforms can link borrowers with funding providers that fit their exact needs and qualifications. In order to determine which lender is right for you, you must first determine what the loan is for, what the amount of the loan is, whether you want to pay it off quickly or over an extended period of time and, what your credit score and financial situation is. The lender who is willing to provide you with the loan you want at the best possible interest rate is the right lender for you.
Our Comparison of the Top Personal Loan Providers
It is essential for those seeking a loan to know who the leading online lenders are and to understand the loan products they offer. At Top 10 Best Personal Loans, we have compiled a list of top lenders and loan aggregators, and extensively reviewed each and everyone one of them.
Our experts have also written dozens of articles discussing the fine points of taking a personal loan for those seeking further information on the subject. Taking a personal loan is an important decision and we aim to give our readers the necessary information to make a confident and informed choice.