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Personal Loans Explainer

By: Kate Samano June 15, 2022

Getting a personal loan used to be a cumbersome process, but now they are the simplest, most flexible credit options available. All you’ll need is an internet connection to get money into your account in as little as 24 hours. But before you apply, you should understand how personal loans work, what they’re best used for, and what their strengths and weaknesses are. Here’s a quick look at what you should know before you apply for a personal loan.

Types of Personal Loans

Personal loans are nearly always unsecured. An unsecured loan means that the only thing guaranteeing payback for the lender is your word as a borrower. But no lender is going to extend you a loan simply because you promise to pay it back. Each lender’s approval depends on the specific metrics of your financial situation, such as your credit score and annual income. Each lender also has different standards targeting different segments of the population, from people with perfect credit and high income to those with poor credit and low income. The lower your credit score and income are, the higher your interest rates will be. Once you’re approved for an unsecured personal loan, you won’t have to offer any collateral or put any of your assets at risk to cover the loan.

In some instances, a secured personal loan may be a better option for you. A secured loan is directly tied to a specific asset to be used as collateral in case you default on a loan. Auto loans, for example, are secured loans, as your car can be repossessed in the event of nonpayment. In theory, this makes a secured loan less risky for a lender, which may enable you to get a lower interest rate.

Styles of Personal Loans

Just like nearly all personal loans are unsecured, in nearly all cases, they all offer fixed interest rates. For most personal loan borrowers, this is actually a good thing, as it takes away the stress of dealing with an interest rate that may rise over the course of the loan. When rates are low, you can lock in a good rate and use your personal loan to pay off credit cards or other high-rate debt. It also sets a fixed payment for your loan, allowing you to factor that into your monthly budget with no surprises.

Uses of Personal Loans

One of the biggest benefits of a personal loan is that it can be used for almost anything. A lender will often ask you what you intend to use the proceeds for, but nearly any answer will usually suffice. Typical uses of personal loans include the following:

  • Credit card refinancing
  • Medical expenses
  • Home improvement
  • Maintenance or repair
  • Consolidation of debt
  • Major purchases
  • Personal use

Borrowers take out personal loans for a host of other uses as well, including paying off bills like income or property taxes. In short, a personal loan can be used for essentially anything under the sun.

Benefits of Personal Loans

Competition in the personal loan field has brought about many benefits for customers. Typically, with an online personal loan, you can expect the following:

  • Fast approval, often within minutes
  • Fast access to cash, sometimes in less than 24 hours
  • Flexibility in terms and amounts
  • Lower interest rates than credit cards, payday lenders, etc.
  • No collateral required
  • No prepayment penalty

Not all loans have all of these benefits, so be sure to check the fine print before you sign on the dotted line.

Things To Know

Personal loans have huge benefits for most applicants, but you should be aware of some potential concerns. For starters, although rates are generally lower than with credit cards and some other options, they can be much higher than with some secured loans, or business financing options. Minimum payments for fixed-rate personal loans can sometimes be higher than the minimum you’d have to pay on a credit card, especially if you choose a very short-term loan, so there could be some impact to your cash flow. Also, some lenders also have hidden fees for prepayment or even for originating a loan, so always be sure to read the loan documents before you commit.

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