What is a Personal Loan?
We know that life happens – you suddenly find yourself with unexpected home repairs or a bunch of credit card debt. No wonder there are millions of people who take out personal loans. According to a study conducted by Experian™, there are 38.4 million personal loan accounts open across the U.S., an 11% increase from 2018.
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 and How Does it Work?
Personal loans are credit products – think of them as a kind of installment loan where you borrow a specified sum of money and pay it back in within a predetermined amount of time. Borrowers will typically head to a bank, credit union or an online lender. Rates can range depending on your creditworthiness.
There are both secured and unsecured personal loans. Unsecured personal loans aren’t backed by collateral. That means a lender will decide whether you qualify based on factors like your credit history and income.
Secured personal loans, on the other hand, are backed by collateral like your vehicle or a savings account. This is to ensure that if you can’t make your payments, the lender will claim the right to take your asset in order to pay off your personal loan.
Your account is considered closed once you pay back your loan in full.
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.
Is it a Good Idea to Get a Personal Loan?
The benefit of obtaining a personal loan depends on your financial situation – it’s a good idea to seek the help of a seasoned financial professional for guidance.
Getting a personal loan can be great if you have a bunch of high-interest debts and you’re looking to roll them into one that has a lower interest rate. You could save hundreds, if not thousands, of dollars throughout the lifetime of your loan. 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.
Where you can get in trouble is with fees and interest rates. Some personal loan lenders may charge what’s called an origination fee – what you need to pay to process the loan. This is typically a percentage of the loan amount and may be rolled into your monthly payments or paid upfront.
While interest rates can be 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? RocketHQ offers credit monitoring for free). Plus, 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.
All this to say – think carefully about the reasons you want to take out a loan. Is it for an emergency or a necessity in your life like a car or repairing your roof? Or is it because you want to purchase a few extra presents during the holidays?
If you can hold off making your purchases for a while, consider setting aside money in a savings account for that purpose. Or for those with an excellent credit score, consider using a credit card that offers a 0% introductory APR and pay it off over time – though you could be at risk of paying a high interest rate if you don’t.
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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