If you are short of money but want to renovate your home, fund studies, buy expensive electronic equipment, or start a small business, personal loans are a great way to meet such expenses. According to estimates, more than 27 million Americans have taken out personal loans. First timers who plan on applying for a personal loan need to know a few basic things.
5 basic things to know when applying for personal loans
1. Types of personal loans
There are two types of personal loans — secured and unsecured loans. In secured loans, you have to provide an asset as collateral to get the loan, say a Certificate of Deposit. This is the easiest option to get a loan and the interest rates tend to be on the lower side. An unsecured loan is one that does not require you to pledge assets. You will typically be given a loan based on your income and employment history. Since no collateral is provided, interest rates will be higher to compensate for the extra risk taken by the lender.
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2. Your credit score is important for unsecured personal loans
As far as unsecured loans are concerned, your credit score will play a huge role in determining eligibility and interest rates. People with high credit scores will have an easier time getting approved for personal loans while also being charged a lower interest rate. In contrast, people with a low credit score will have a tough time getting funds. Even if a loan is approved, interest rates will be on the higher side. Those with low credit scores should try to improve them before applying for a loan if they wish to avoid high interest rates. This can be done by repaying existing debt and maintaining a clean credit record for a few months.
3. Don’t just focus on banks
Do not be fixated on banks alone for personal loans. Institutions like consumer finance companies, credit unions, and private lenders can also be good options. Some of them may even offer flexible repayment schedules and lower interest rates than the banks. For people with bad credit, such alternative lenders are often the only way to get a loan, though at extremely high interest rates. In recent times, peer-to-peer lending has also gained prominence where you can get a loan directly from an individual through the Internet.
4. Interest rates
Usually, interest rates on personal loans are fixed. So if a loan charges you 3.5 percent per annum, it will keep charging the same rate of interest throughout the loan term. However, some lenders do offer a variable interest option where your interest payments will vary depending on economic conditions. While a fixed interest loan will give you the peace of mind knowing exactly how much you need to pay every month, variable interest loans offer you a chance of reducing interest payments in the future.
5. Other charges
Interest rates are not the only charge you will be paying for the loan. Lenders usually charge you an origination fee to cover the cost of processing the loan. This can range anywhere from 1 to 6 percent of the loan amount. You need to factor in such costs when deciding to take the loan. Plus, keep in mind that lenders often charge a prepayment penalty in case you decide to pay off the loan before the end of the loan period.