How do personal loans work?
Where can you get a personal loan?
You can get a personal loan from many financial institutions, including online and traditional (in-branch) lenders. If you want to see some of our favorites, check out our updated list of the best personal loans.
Types of personal loans
Although all personal loans fall into the same general category, there are some subcategories you should be aware of:
- Personal loans for good credit – Many personal lenders focus specifically on “primary” borrowers, that is, consumers with a strong credit history.
- Personal loans for bad credit – Some companies offer personal loan products intended for borrowers whose credit is not optimal.
- Personal Loans for Debt Consolidation – These loans allow you to combine (or “consolidate”) multiple debt payments (credit cards, car loan, etc.) into one payment. A debt consolidation loan usually has a lower interest rate, which means you will likely have a lower monthly payment.
- Medical loans – A medical loan is generally used to pay for health costs.
- Home Improvement Loans – These types of loans can help finance home improvements, like installing a swimming pool, renovating a bathroom or kitchen, or finishing a basement.
- Coronavirus Hardship Loans – If your income has been reduced by COVID-19, you may be eligible for a Coronavirus Hardship Loan. These loans are smaller and meant to help you pay the bills during a short period of unemployment.
How Does a Personal Loan Affect Your Credit Score?
A personal loan can improve your credit score – if you make the loan payments on time.
This is especially true if the personal loan is used to consolidate credit card debt. On the one hand, installment debt (loan debt) is generally considered to be more favorable than revolving debt (credit cards). Also, the borrower’s credit card usage percentages will be much lower after consolidation (you won’t be very close to maximizing your credit cards). It can also give your score a big boost.
How to choose a personal loan
If you are looking for a personal loan, there are a few things you should pay attention to.
Understand the important concepts of personal loan
Before shopping for a personal loan, there are a few concepts you should know in order to make the best decision for your financial situation:
- Credit and income conditions. Read each lender’s minimum credit requirements to make sure you qualify before you apply. Some lenders also have income requirements.
- Interest rate. This is arguably the most important feature to pay attention to, as it is the primary determinant of the cost of your loan over time. You want to get the lowest possible interest rate. Pay close attention to annual percentage rates, or APRs, which include the interest rate on the loan as well as the origination fee (if applicable).
- term of the loan. The term of your loan is the time you have to repay the loan. You want to pay off your loan as quickly as possible to save money on interest. But shorter loan terms also mean larger monthly payments. Of course, you never want to take a loan with a monthly payment that you can’t afford.
- Amount of the loan. Personal loans can range from $ 1,000 to $ 100,000. Take enough to cover what you need, but never borrow more than you need.
- Origination fees. Although this is not very common, some lenders charge a set-up fee. This is usually a percentage of the total loan amount. Look for loans with minimal origination fees or no fees.
- Penalty for early payment. A prepayment penalty is a fee that a lender can charge if you pay off your loan before the end of the loan term. Avoid loans with prepayment penalties, as it’s always best to pay off your loan in advance when you can. The good news is that prepayment penalties are not common in the personal loan industry.
- Secured or unsecured loans. Most personal loans do not require collateral – they are called “unsecured” loans. This means that the lender cannot take your car or your house if you cannot pay the loan. But if your credit is poor, you might not be eligible for an unsecured loan. In this case, you may need to offer collateral (such as money in a savings account or CD) to qualify for a loan.
Get the best interest rate
The interest rate you will pay on your personal loan can vary depending on several factors, including your credit score and your lender. Here’s how to make sure you’re getting the best deal.
Improve Your Credit Score
Generally, you will get a low interest rate if you have an excellent credit rating.
If your credit score needs improvement, don’t worry – you can still get a personal loan for fair credit. These OakParkFinancial — same day loans usually charge a higher interest rate, but the interest rate will always (usually) be lower than the interest rate on a credit card. There are also several ways to build credit fast, if you want to try increasing your score and improving your chances of getting a low interest rate.
Compare several lenders
It is not uncommon for a borrower to find loan deals with a difference of 8 percentage points or more in the interest rate, even when going to the best personal lenders. This means that if you are applying to a group of lenders, offers with an APR ranging from 8% to 16% would not be unusual. What if you only apply to the 16% APR lender? You will never know what interest rates are available unless you apply to multiple lenders.
Most personal lenders allow you to Get pre-approved, which includes checking your interest rates, in just a few minutes. An hour or two of shopping around for loans is easy and could save you hundreds (if not thousands) of dollars.
Know how long you need to pay off the loan
It can be tempting to choose the longest possible loan repayment term to keep your monthly payments low. However, it is wise to consider paying off your loan as soon as possible.
Let’s say you borrow $ 20,000 to finance home renovations at an 8% interest rate. Paying off the loan over a 48-month period would result in a monthly payment of $ 488.26, while a 72-month term would come with a payment of $ 350.66 – keeping an additional $ 137.60 in your wallet every month.
However, in the longer term, you would pay $ 5,248 in total interest, while the 48-month loan would have a total interest charge of $ 3,436. By choosing to pay a little more each month, you save $ 1,812 in the long term.