How Does A Personal Loan Work? Loans 101
Sometimes there are events, services, and unexpected expenses that arise. When they arise, we must consider whether we have the funds to make the purchase or if we need to consider a loan. One of the options available for funds during these scenarios includes a personal loan. Before you take on a personal loan, however, it is essential to know how does a personal loan work. Also, have a look at what is needed for requirements and where to find them.
What Is a Personal Loan?
Simply put, a personal loan refers to borrowed money from a bank, credit union, financial lender, or online financial company. Anytime a person takes out a loan for an expense, it is considered a personal loan. Personal loans have the ability to come in any amount from as little as $500 to $20,000. It depends on the institution, personal credit score, income, and other necessities for acquiring a loan.
Personal loans also have the ability to come in a variety of interest rates. Those can be as versatile as the amount that is being requested. Like the amount, the interest rate is based on the different factors of a person’s financial history and criteria. In order to know how does a personal loan work, that person must have a thorough understanding of their personal finances. Understanding thing before you get a personal loan is necessary.
What Types of Personal Loans Are There?
A personal loan has the ability to be for almost any expense you can think of. Below are some of the most common types of personal loans:
- Loan for Medical expenses
- Wedding loan for a ceremony and the reception
- Vacation loans for your get away planning
- Debt Consolidations
- Home improvement projects
- Eliminating credit card debt
- Paying off a higher interest personal loan
- Purchasing a boat, RV loan, or ATV
These are some of the most popular reasons that someone is seeking out a personal loan. Any additional expense or extra purchase you would like to make often comes with the need for personal installment loans. At least in order to conveniently afford the expense. Some of these personal loans are emergency and happen on a whim. In the meantime, others are planned and budgeted for by the person and their monthly budget.
The smaller personal loans refer to things like an unexpected bill or medical bills. On the other hand the larger personal loans are for planning weddings and making purchases of recreational vehicles. No matter what your need or may want, it is a reason for a personal loan.
Secured Personal Loans vs. Unsecured Personal Loans
A personal loan is approved on the condition of secured personal loans vs unsecured personal loans.
Secured Personal Loans
When someone asks how does a personal loan work that is secured, the answer is simply collateral. Collateral refers to the person giving temporary ownership of their property to a lender in order for them to secure the loan. It then provides them the funds needed. Should you not make the agreed upon payments, the collateral that you used to secure your loan will become the property of the lender. Indeed, they will take ownership. Once they secure the property that they now own, they will give you many days to pay your obligation to them before they permanently take ownership of the property. This way, they give you a final chance to regain what is yours.
A benefit to a secured personal loan is that because the lender is securing property for the loan, they often offer lower interest rates for their loans. It makes repayment for the loan much easier than it is with those that are unsecured.
Unsecured Personal Loans
If someone is approved for an unsecured personal loan, they should know how does a personal loan work in this format. When approved for an unsecured personal loan, the lender offers the loan strictly on past credit history. He finds it sufficient enough of the applicant to not require collateral. It’s often explained as their risk rate for not paying back the loan is low.
Unfortunately, some lenders take this to their advantage when the applicant is planning to shop personal loans. They decide to raise the interest on the loan, making repayment and monthly payments higher for the applicant. For some applicants, this can make the payment extend beyond their monthly budget. It then eliminates the option for a personal loan at that time.
What Can I Use As Collateral For A Personal Loan?
If you are considering taking on a secured personal loan, you should know what is the best type of property to use for securing the loan. Below are the different types of property that are available to most applicants that can be used:
- Paid Off Vehicle
- Ipad or Tablet
- Cell Phone
Above are the most common types of property used to secure personal loans on a daily basis. Before using your property to secure a loan, understand how does a personal loan work when it is secured. Then figure out which you should offer for your personal loan.
If you are planning to obtain a small secured personal loan, you do not need to use your vehicle as collateral. Do not risk a valuable investment for a loan that you could potentially get behind on and find yourself forfeiting property. For small loans, consider things like jewelry, televisions, and printers. Small collateral items that you could part with if you needed to is what you need to consider for the smaller loans.
For larger loans that require securing, which is anything at $5,000 or above, you can then consider your recreational toys. This includes your ATV, boat, or even your vehicle if the amount substantiates the property amount. For each loan amount in a secured loan, your lender will have a set value they are trying to acquire, and they will evaluate your property to determine what will work as collateral.
Who Else Is Using Personal Loans?
When you are checking into personal loans and learning how does a personal loans work, you may find yourself surprised at the number of people who are using personal loans in this day and time. Statistics regarding personal loans determine that 1 out of 5 people today have an active personal loan. Or at least had one in recent years that has now been paid off. What this information provides is that it is a common practice that some may have once frowned upon but are now in need of these loans themselves. Whether someone has a high credit score or falling below fair for a score, there is a growing need for these personal loans.
More and more, lenders are approving loans for things that they would not have done half a century ago. For instance, it includes weddings or vacations. Personal loans allow these two events to be more attainable than past generations and lending practices. Lenders are also finding themselves filled with applications for personal loans to pay outstanding medical bills. Especially due to the rise in health care prices and practices as the generations change.
What Is The Required Credit Score?
When learning about how does a personal loan work, applicants find that the credit score has an impact on the approval process of a personal loan. Depending on the financial institution in which the applicant is applying, the required credit score can vary.
Obtaining a personal loan from a bank or credit union is usually reserved for those with the best of credit scores. Those whose credit score reaches 750 or higher find themselves applying for personal loans through these institutions. Their credit score will not only land them the amount in which they desire. Indeed, they will also be provided with an interest rate that is much smaller than any other institution will offer them.
Local Financial Lenders/ Pawn Shops
The smaller finance companies and pawn shops in the areas are available for the citizens who do not have a lavish credit score. For those with fair or bad credit, their options are limited to the institutions that offer both secured personal loans and also high interest personal loans. For the pawn shops, expect both a high interest rate on your loan as well as securing it with property. The personal loan finance companies who require collateral for their loans will have a smaller interest rate than the pawn shops.
Many online lenders offer loans based upon the credit score. Since the interaction between applicant and lender is strictly online, many of these loans are offered as unsecured loans to the applicants. In other words, it requires no collateral. However, they are allowed to charge a much higher interest rate. This one is however depending on the state and what is allowed legally. Many of these loans find themselves with interest rates well over 100%. Coming with high monthly payments for those that are borrowing the money and often repaying the loan in a short time frame.
Is There An Income Requirement?
Like the credit score, the income amount is important for applicants when learning how does a personal loans work and what is required for approval. Debt to income ratio or an overall income total is reviewed by these lenders. The aim is to determine if you have the ability to repay the loan. This is very important to top tier lenders such as banks and credit unions that offer the best personal loan packages in the lending world.
As you work your way down the levels of financial lenders, income becomes essential to just prove it. The debt to income ratio is no longer as important as it was with a prior lender. Essentially, all you need by the time you are seeking online lenders or local financial institutions in your hometown is just current pay stubs proving that you have a solid income. The aim is more about proving that you make enough money to cover the minimum payment. It is important to keep in mind that these lenders are not considering any additional monthly responsibilities you may have. They will treat your loan as though it is the highest priority in your monthly budget.
Should I Expect Additional Fees?
Depending on the lender that you are using, additional fees on a personal loan can come in the following:
- Application Fee
- Early Payoff Penalty Fee
These fees have been known to be present in personal loans for those with bad credit. All personal loans, whether they are with the bank or credit union or an online lender, will have a late payment fee applied to the terms of the agreement and that is only fair. However, fees such as an application fee are not always associated with a personal loan. They are however something to heavily consider when applying for your personal loan. Also, consider the other fees such as a penalty fee for early payoffs. Most financial institutions encourage early pay off because it is financially responsible.
However, some lenders want every dollar agreed upon in your lending agreement. Then this fee is used to make up some of the interest lost if you pay off early. Some lenders also view this as breaking a contract and treating it like a lease contract. In this case you are considered leaving the agreement before it is over. Be sure that these lenders should be last resort lenders.
What Can I Really Afford?
Taking on a personal loan payment is no small feat for those who are living life on a budget. While you may have an idea of what you want in a personal loan, it is important to know what you can actually afford. Then you have to make sure the loan is something that is financially achievable. Learn how does a personal loan work and use that to your budgeting advantage when deciding on your personal loan and the reasons for the loan.
What’s My Budget?
Before you apply for a loan, review your current monthly budget obligations against your income amount. Consider the following payment obligations:
- Car payment
- Car Insurance
- Cell Phone
- Childcare (if necessary)
Do you have enough money left over now that you can make that payment monthly? Will you be able to survive on the remaining amount? This is what is known as the debt to income ratio. Applicants use it in order to accurately determine how much of a loan they can afford monthly. Review the last three months of your bills and the income that you generated. Determine the amount that you have to the plus. Then determine exactly how much you need for weekly survival. This is the money you need for food, automobile gas, and household necessities. Whatever is extra is what you can afford for a monthly payment towards a personal loan.
How Much Do I Need?
Just because you may be pre-approved for a larger loan amount, this does not mean that you need to take all of the loan available. Determine exactly how much money is needed to cover the cost and do not take additional money beyond that point. Not only do you have to pay back that extra amount. The monthly interest accrued on your outstanding balance will be more monthly because you borrowed more money. It is not a smart idea to take more money than you need for a loan, even if it is something as flexible as a wedding cost. Even then, you need to construct a budget and stick to that amount during planning so that you can maintain financial stability and pay for the event or expenses that you desire.
How Can A Personal Loan Help My Debt?
Now that you know how does a personal loans work, there is room for debt assistance with a personal loan. If you currently have an outstanding debt that is accumulating at a higher interest rate than what you were approved for with your personal loan, you can use this money to pay off the existing debt, and pay back the personal loan. This will allow you to save hundreds of dollars in interest monthly, and build your credit score. This works the same for credit card consolidation or overall debt consolidation that allows you to combine all of your monthly payments into one payment, saving you money each month on expenses and bills.
How Can A Personal Loan Hurt Me Financially?
While the leading lenders such as banks and credit unions review your debt to income ratio, other lenders do not have the same regard for your financial security. Because of this, they may offer you a loan that you can not financially afford, leaving you with high monthly payments and your debt continues to grow by the hundreds in interest. If you irresponsibly take a personal loan that you cannot afford, you will be repaying this debt in hundreds of dollars of interest that could have been avoiding with the proper understanding of your financial obligation.
Where Can I Get A Personal Loan?
When you are looking to loan shop, consider the following for a personal loan.
- Banks/Credit unions
- Local Financial Lenders
- Title Loan companies
- Pawn Shops
- Online Lenders
With banks and credit unions offering the best options for personal loans, those with the best credit should seek out these institutions only. If your income is solid and your credit score qualifies as good, it is time to apply at the bank.
Local Financial Lenders
For those will less than good credit, but it is fair, you should consider the local financial institutions found in your community. They may require your personal loan be secured with collateral coverage, but the interest rates will be only a little higher than the bank or credit union.
Title Loan Companies
If you have bad credit and require a small personal loan for an unexpected expense, you can consider the title loan companies that require your vehicle title for collateral or the local pawn shop that will hold your property while you pay back your loan. These loans are some of the last resort options that should be considered only in the case of a financial emergency.
Finally, you have the ability to search for lenders online. By using a lending service finder tool, you are able to seek out lenders based upon your credit score and income. With this tool, you only have to provide minimal information and you are met with options that range in loan amounts, loan terms, and loan interest rates. For those with fair credit, there are online lenders available that have comparable loan terms and interest to the local bank or credit union. However, there are also lenders online who take advantage of those with bad credit, and offer unsecured loans at interest rates that are almost impossible to repay. Because of this, it is important to understand why you should use the lender service finder tool and evaluate the lending options you have available.
Make Your Personal Loan Decision
Learning about personal loans and how does a personal loan work can empower your decision regarding your finances. While personal loans are a hot commodity and so many in society have taken advantage of these loans options, that does not mean that your financial security should be negatively impacted in order to obtain a loan. First and foremost, it is important to understand why you want the loan, why it is necessary and if the loan is even affordable. Ensure that you have sought out the best personal loan based upon your credit and income, and the monthly payments are something that can be easily maintained each month.
If you find yourself in a situation where a secured loan is the right option for you, make sure that you have considered all of your property options and are only using property that you can easily part with as collateral for your loan. Finally, understand the impact that the personal loan may have on your for the long term and your finances. Once you have evaluated all of these areas and reviewed your personal finances, you will be able to make a solid personal loan decision.
About the Author – Kasey T
Ethan founded OfferEDGE in Dec 2013 with the mission to unify the financial quadrants through a system that allows businesses to be seen when consumers use a Single Sign On across Lending, Credit, Money and Real Estate. Taub invents the offers and IP, while overseeing all aspects of the company. He also has orchestrated the company’s earned media across the brands Loanry®, Cashry®, Debtry®, Budgetry®, Billry®, Taxry® and more. This includes over 500 publications that have been featured across the web.
He has more than 18 years of experience in C-level Management, Sales, Marketing and Product Development across billion-dollar brands to innovative technology start-ups. Taub holds a degree in Economics from the University of California, Berkeley.