Personal loans provide you a sense of financial security when you make payments on something you cannot afford outright. With a personal loan, you borrow money from a bank or a financial lender. This money must be paid back through regular installments over an agreed-upon period. Typically, you have anywhere between one year and seven years to repay your personal loan with interest.
The interest rate you agree to pay each month is usually a fixed rate, though this may vary depending upon the lender. In most cases, your interest rate is determined by your personal credit score. The higher your credit score, the lower the interest rate. Other factors may influence this, however.
There are advantages and disadvantages to using a personal loan when you are struggling to pay for something out-of-pocket. Weigh the pros and cons of applying for a personal loan before committing to this financial endeavor as you may end up paying more long-term by choosing a personal loan. More information about choosing a personal loan is covered below.
What Are the Different Types of Personal Loans?
Before you decide on taking out a personal loan, it is important to determine what type of loan works best for your financial requirements. There are two primary types of personal loans to choose from, with each providing a different set of benefits:
- Unsecured loans are personal loans not backed by any sort of collateral. This means when you apply for a personal loan, the bank or lender assesses your financial history to determine whether you qualify. If your financial history is unstable, you may be disqualified from receiving an unsecured loan from the lender of your choosing. Unsecured loans put the bank at a higher risk, as you are not providing any collateral for the money you are requesting. As a result, your interest rates are most likely going to be higher each month.
- Secured loans are personal loans backed by collateral. These types of loans are less risky for the bank or financial lender. Collateral items include your home, vehicle or the money you currently have in either a savings account or a certificate of deposit. This puts you at a higher risk, as you may have whatever item you put up for collateral repossessed when you fail to meet the required payments for your loan. Typically, it takes several missed payments before your items are repossessed, but if you have a history of missing payments your lender may go after you right away.
In general, if you do not have anything of value to offer as collateral but are confident in your ability to meet your monthly payments, choose an unsecured personal loan for your financial needs. If you do have something to offer as collateral but are unsure of whether you can make the monthly payments, opt for a different lending option you can repay without risking your possessions.
What Are the Pros of a Personal Loan?
One of the clear advantages of taking out a personal loan is the freedom you acquire from the loan. Unlike other loans, personal loans do not need to be used for one specific item and you do not have to justify your use of the money to the lender. For example, if you are planning your wedding and notice you are several thousand dollars short of your required budget, taking out a personal loan provides you with the added funds without restriction.
The amount you borrow is dependent upon your personal needs, with many loans issued anywhere between $1,500 to $100,000. However, when you ask for larger loans your lender often has the upper hand in negotiations. He or she is more likely to set harsher conditions to justify lending you such a large amount of money, so make sure you are only asking for what you truly need.
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Applying for a personal loan is possible regardless of your credit score, though the interest rate you pay per month for your loan is typically lowered when you have a good credit score. Borrowers with a reasonable credit score pay approximately five to 13 percent interest rate toward their loan whereas borrowers with a poor credit score pay around 36 percent interest rate. While this may seem steep, the highest interest rate attributed to a personal loan is lower than the common interest rates utilized in other popular loan options.
What Are the Cons of a Personal Loan?
Personal loans become tricky when you are unable to pay the designated amount on time. When you agree to the terms of a personal loan, you agree to pay a fixed rate for the duration of the loan agreement. This means you are not permitted to pay less than one month if you are unable to meet the previously agreed upon rate. When this happens, you run the risk of having an item repossessed if you have offered collateral for your loan.
If you opted for an unsecured loan, the bank or lender can sue you for the missed payments. Learn how to manage debt if you’re not sure how to effectively pay off your loan.
With a personal loan, you may be assessed a prepayment penalty if you choose to pay the remaining balance of your loan in full when you become financially able to do so. Several banks and financial lenders choose to assess a prepayment penalty as a means of making up for the lack of interest rate payments once you have repaid your loan. Before you choose to pay down your loan, speak with your financial lender to determine what the prepayment penalty may be and decide if you can afford to pay this added fee. Not all lenders have such prepayment penalties, so it is a good idea to compare shop.
Another disadvantage of using a personal loan is the potential for an origination fee at the time of your account establishment. Some lenders and banks issue an origination fee to help cover the cost of any processing fees associated with establishing the loan. This origination fee can range anywhere between one to six percent of the amount you are borrowing from the lender, which adds to the total you are paying for this privilege. You are required to pay the origination fee upfront or else you forfeit your qualification for your loan. Some lenders may waive this fee as an incentive to attract borrowers.
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