HOW DO PERSONAL LOANS WORK?
Personal loans can be a great tool to help you pay for large expenses. People use them for a variety of reasons including debt consolidation, to pay for the unexpected, and home renovations to name a few.
If you need cash quickly or you are looking to consolidate debt at a lower rate, personal loans can be a great tool in your finances. However, it's important to understand how they work and what your different options are before making a decision. It’s a big financial commitment, and you want to be sure you choose what’s right for you.
What types of personal loans are there?
An unsecured, fixed-rate variable loan is the most common. In this, the lender pays a lump sum of money, and the borrower has fixed payments that they repay over a specified amount of time. Just like car payments or your mortgage, the payments never change and you know exactly when the bill will be paid off.
Personal loans can come in other variations. There are secured and variable-rate options. These may give you a lower interest rate. Secured loans are backed by collateral, which makes you less risky to the lender, thereby getting you a lower rate. And variable-rate loans have an interest rate that changes based on the market rate. This can be a good thing if rates are low but can cause unexpected changes in your bills if market rates go up.
What do people use personal loans for?
People take out personal loans for many different reasons. They’re useful for consolidating debt. It’s convenient to have all your bills in one monthly payment with an end date in sight. As long as your personal loan interest rate is lower than your previous debt, you can save money while you simplify your finances.
People also use them to pay medical bills, home renovations, car repairs, weddings, and funerals. Lenders usually want to know the reason for the loan and lenders generally have some restrictions.
How do credit scores affect loan rates?
Personal loans are typically offered at rates from 5 to 36 percent. The higher your credit score, the more competitive rates you will be offered. Most lenders have a minimum credit score requirement of 580 to 600. These scores will have the highest interest rates, and it gets progressively better as your scores improve.
If your score is below 580, you can still obtain a personal loan, but it may be harder to find and require putting down collateral or getting a cosigner.
What to watch out for
- Prepayment penalties. Some loans charge fees if you pay your loan off early. Watch out for this and be aware before you sign if your loan is going to charge you for paying early.
- Other fees. There may be origination fees or other types of service charges. Be sure to read the fine print. These fees usually range from 1 to 6 percent.
- Fixed-rates versus adjustable rates. If you choose an adjustable-rate loan, you need to be aware that your payments can go up and down based on the market. Look for one with a maximum interest rate so your payments don’t get out of control.
Personal loans can provide some big benefits. You can improve your credit score by consolidating credit card debt into a personal loan. This increases your credit utilization ratio by giving you more available credit which has a big impact on credit scores.
You have a lot of choices when it comes to personal loans. Do your research and make an informed decision so you can choose the options best suited for your situation.