What is a Personal Loan?
Who couldn’t use a little extra money to consolidate credit card debt, modernize their home or pay for their wedding or other big-ticket item? One smart solution is a personal loan, which typically offers fixed rates and lower minimum borrowing amounts than other financial vehicles. Because of these and other benefits, personal loans are trending, with 11% year-over-year growth, according to Experian™.
Is a personal loan right for you? Here’s what you need to know.
What makes a personal loan so appealing is that it can offer a fixed interest rate and typically lower minimum borrowing amounts. That being said, it’s not for everyone. Learn what a personal loan is, how it works and whether it’s the best choice for you.
What is a Personal Loan?
A personal loan is a type of credit known as an installment loan, where you borrow a specified sum of money from a bank, credit union or online lender with a fixed interest rate and pay it back within a predetermined amount of time. Your interest rate will vary depending on your creditworthiness – the higher your credit score, the lower your rate will be, which means you will pay less over the life of the loan.
Personal loans are personal, meaning you can use a personal loan for a wide variety of reasons. According to the Experian™ survey, the top three reasons that people took out personal loans were for large purchases (28%), debt consolidation (26%) and home improvements (17%).
But that's not all! Here are some additional key reasons people use personal loans:
- To pay down medical bills – If you can’t negotiate high medical bills for lower terms, a personal loan allows you to pay them off so they don’t ding your credit. You’d then pay the personal loan back in installments.
- To consolidate debts – If you have multiple loans, you can combine them into one personal loan as a method of debt consolidation, to help make payments more manageable and possibly achieve a lower interest rate.
- To finance a vehicle – It pays to shop around, but some personal loans may have lower interest rates than auto loans you might get at the dealership.
- To fund your small business – Whether you’re expanding your operation or need to take on extra marketing expenses, a personal loan can help your small business move forward.
- To make home repairs – If you have small repairs or home improvements you want to make and don’t want to take out a home equity loan, a personal loan can be a great way to cover the costs.
- To fund a wedding or vacation – These once-in-a-lifetime events can be costly, and a personal loan can often help cover the expenses more affordably than using a credit card.
What is a Personal Loan Used for?
Personal loans can be used for myriad reasons.
Here are some of the most popular ways people tend to use personal loans:
- Pay down medical bills – If they can’t negotiate down bills any further, people use personal loans to pay high bills off, then pay their personal loan back in installments.
- Consolidate debts – Those with multiple loans that charge a high interest rate can be consolidated into one with a potentially lower rate to help make payments more manageable. These can include student loans, credit card debt or tax debt.
- Financing a vehicle – Personal loans may have lower interest rates compared to ones you’ll find at the dealership.
- Making home repairs – If you have small repairs or renovations you want to make and don’t want to take out a home equity loan, a personal loan can make sense.
- Fund a wedding or vacation – Vacations and weddings can be expensive, and many folks take out personal loans to pay for these costs. Same goes for those who celebrate the holidays.
How Do Personal Loans Work?
To see if you qualify for a loan, first check your credit, as that can be an important decision-making factor for the lender. Then, you’ll provide some financial information to get started and see the loan options that are available to you. Once you choose one, you’ll supply more detailed information, and your lender will consider your suitability. Within days, you’ll receive your approval, if all goes well, along with all the payment terms for you to agree to start the funding.
A personal loan comes with a defined term, for example, 3 to 5 years, and a fixed payment. It’s considered closed once you pay back your loan in full and can’t be renewed – you’d have to apply for another one if you decided that you wanted or needed one for another purpose.
Personal loans are either “secured” or “unsecured.”
Secured Personal Loan
A secured loan gets backed by some type of collateral, such as your vehicle or a savings account. If you don’t make your payments, the lender has the right to take that asset to pay off the personal loan.
Unsecured Personal Loan
By contrast, an unsecured personal loan isn’t backed by collateral, which means that a lender will decide whether you qualify based on factors like your credit history and income. If you have bad credit, an unsecured personal loan can be harder to get because lenders won’t be as confident you’ll pay it back.
Is a Personal Loan Right For You?
The benefit of obtaining a personal loan depends on you – as with any financial decision, it’s a good idea to seek the help of a seasoned professional for guidance.
For most people, getting a personal loan can be a great strategy to simplify complicated bills and roll several high-interest debts into one that may have a lower interest rate. Not only will it be much easier to pay just one bill instead of several, but you could save hundreds, if not thousands, of dollars over the life of your loan, thanks to that lower interest rate.
Or if you find that you’re in a tight bind – such as needing a new car because your old one died – then a personal loan can come to the rescue.
Before you sign on the dotted line, make sure you understand all the terms of the loan:
- How much the interest rate is – while usually the interest rate is lower than other types of loans, they can still be high, especially if you don’t have a stellar credit score (don’t know what yours is? RocketHQSM offers credit monitoring for free).
- Whether there’s an origination fee, which is what some lenders charge to process the loan. This is typically a percentage of the loan amount and may be rolled into your monthly payments or paid upfront.
- How long the loan is – the longer the loan term, the more interest you’ll be paying. You can pay off your loan early, but some lenders charge a prepayment penalty – a fee for making early payments.
- Your total monthly payment – make sure you can commit to paying this amount on time each month for the life of the loan, otherwise you could be looking at late fees and potential negative marks on your credit report if you fall seriously behind.
After taking all that into consideration, weigh it against the reasons you want to take out a loan. Will the personal loan simplify your life by eliminating excess bills and offering you a lower interest rate? In that case, it might be the right choice for your financial well-being.
How Rocket Loans Can Help
A personal loan can be a great choice for those who need money for things like debt consolidation or home repairs. However, there are other financial considerations to think about before signing the dotted line – one of the most important being whether or not you can afford the payments.
It’s probably a good idea to sit down and crunch some numbers before getting a personal loan to see whether it makes sense, or if there is some wiggle room in your budget now to save up for your goal for a little while. In any case, you need to know where you stand – understand and monitor your credit situation so that you can get the best rate possible.
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What Type of Loan Do I Need?
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