Understanding How Personal Loans Work

There are many types of loans that you’ll find in the loan market today. One of the easiest to understand is the personal loan.  

When you apply for a personal loan, the lending institution lends you money for a fixed period with a fixed interest rate. It means that you will have to make a fixed monthly payment so there are no surprises unlike with a credit card in which you have no idea how much you’ll be paying in a month unless you make a record of everything you spend on.  

But this is not to say that personal loans are the always the best solution to your money problems. As with any other type of loan, it also has its own risks and drawbacks that you have to know about in order to make the right decisions. The interest rates, and the vicious cycle where you might get trapped are some of the things that you have to worry about.  

It’s imperative to know how personal loans work to ensure that you don’t get into any problem, and so you make the most of what it has to offer.  

How do personal loans work? 

As mentioned earlier, it’s easy to understand how this type of loan works. You borrow a specific amount of money at a fixed interest rate, and then you pay a fixed monthly amount until the loan has been completely paid off.  

The terms of personal loans vary widely depending on various factors. Typically, banks and other lenders can let you borrow up to $35,000 while the payment durations range from 12 months to 20 years.  

Fees and charges 

The first thing that you have to look at when taking out a personal loan is the interest rate. The interest rate varies widely, but expect that these are higher than the interest rate that comes with secured loans such as car loans and home equity loans.   

This is because personal loans are unsecured loans. This means that the loan is not secured with any collateral. If you default on payment, the lender does not have the power to repossess your property or car.  

It’s a must to analyze the interest rates of the personal loan you are getting, as well as the annual percentage rate (APR). 

Keep in mind however that the interest rate is not the only thing that you have to know about personal loans. Aside from this, there are other fees that you need to pay for such as the origination fee, which can be anywhere from 1 percent to 8 percent.  

Since there are now many lending institutions that offer personal loans, the borrower can easily find competitive rates if he conducts a comprehensive research. Some banks even waive the origination fee and other upfront fees.  

Qualifying for a personal loan 

While it’s true that there are now many lending institutions that offer personal loans, the application process can still be a little complicated. In order to quality, you need the following:  

  • Good credit rating – Loan companies will always look at your credit score before approving your loan application. You will need to have a credit score of at least 580. An excellent credit rating of over 740 is so much better as this will give you better rates and terms. Do not apply for a personal loan with first looking at your credit score. Make sure that you take the time to improve it to get good rates and better chances of approval. 
  • Proof of repayment – You will also be required to prove to the lender that you will be able to repay your loan. Employment certificate as well as income statements are some of the things that you need to submit to the lender.  
  • Low debt-to-income ratio – Many lending institutions look at the borrower’s debt-to-income ratio during the loan application. If your recurring debt exceeds your income, there’s a big chance that the lender will not approve your loan. It is recommended to get rid of other debts first, or at least keep the ratio down to 36 percent.  

A personal loan can be the quick answer to your financial problems. However, you need to do ample research so that you do not run into any problem.