The basics of Personal Loans

When shopping for a personal loan, the two most important factors are choosing a reputable lending partner and finding a low interest rate. We’ll soon have first part covered here – our experts are working on identifying the lending partners that are the top choices for factors like avoiding hidden fees and providing good customer service.

Interest rates will vary for everyone based on criteria like credit score and income, so make sure you shop around to find the lowest rates for you.

Millions of consumers have used personal loans to refinance high-interest credit card debt, pay off household bills, or simply divide a large expense into monthly payments that fit their budgets.

A personal loan offers more flexibility than virtually any other type of loan because you can use them for many things, from car repairs to a bathroom remodel, making them a go-to solution for when you simply need cash to make ends meet. Here’s what you should consider when taking out personal loans, to help you make a decision that fits your financial needs.

What is a personal loan?

Personal loans are defined by two basic characteristics. First, personal loans do not require collateral, in contrast to a car loan, which is backed by the value of your car, or a mortgage, which is backed by the value of your home. Secondly, a personal loan is an amortizing loan, meaning the balance goes down every time you make a payment, eventually repaying your balance in full.

Personal loans are typically used for two main purposes:

  1. Paying for personal expenditures — The good thing about personal loans is that they can be taken out for virtually any reason. Some common reasons include making home improvements, paying for car repairs, or to pay for a vacation.
  2. Refinancing existing debt — Personal loans are excellent for refinancing high-interest debt at a lower interest rate. For example, it can make sense to use a personal loan to consolidate and refinance high interest credit card debt. Reducing your interest rate from a common credit-card APR of 20% to a personal loan rate of 10% or less can save you a fortune in interest.

Personal loans are very common. In addition to traditional banks, there are also many different online loan providers where you can apply for a personal loan and get an instant or nearly-instant decision on whether or not you qualify for a personal loan for your specific needs.

Applying online for personal loans

The process of applying for a personal loan is pretty straightforward. The lending partner will ask for pertinent information about you, including how much you earn, how much you spend on rent or mortgage payments, where you live, and how much you’d like to borrow. Some may also ask for bank statements and other financial forms.

The lending partner decides whether or not to approve you for a loan, and what interest rate you’ll pay, based on information you supply to them. After approval, the step-by-step process goes a little like this:

  1. You receive your loan disbursement — Some lending partners do this by check, but most now simply send the money to your checking or savings account via electronic transfer, which puts the money in your account in as little as 24 to 48 hours. The speed at which you can get approved for a personal loan and get access to the amount you borrow is one of their biggest perks.
  2. Repayment — Personal loans typically require monthly payments to repay your balance. During the repayment period, you will be responsible for making a consistent monthly payment to repay your balance over time. For example, a £5,000 36-month loan at an 8% APR would require monthly payments of £156.68 every single month. After 36 months, the loan will be repaid in full, and you won’t need to make any additional payments. Tip: Some lending partners may give you a discount on your interest rate if you agree to automatic drafts from your checking account to pay your loan each month.
  3. Payoff — When your loan is paid in full, you’ll receive a payoff notice declaring that your loan has been repaid. If you’d like to pay loan off earlier than originally planned, speak to your lending partner. While it may seem like lender would be happy to get the money back early, it’s actually a bit more complicated. Depending on the original agreement, there may be fees involved in an early payoff, though some agreements allow for fee-free early payoffs.

Why get a personal loan?

Getting a personal loan can be a good idea if you need financing for a certain purchase or expense that cannot be financed less expensively with a traditional secured loan. Here are the three occasions in which it makes sense to consider a personal loan.

Unsecured personal loan rates

Interest rates on a personal loan vary based on your income, credit score, and how long you want to borrow the money. Low-APR personal loans for people who have excellent credit can carry interest rates as low as 3%, while borrowers who have bad credit will pay as much as 35% per year in interest.

You will pay a higher rate on a personal loan than you’d pay on a car loan or mortgage, but the rate should be lower than the rate you’d receive from other unsecured loans like credit cards.

The reason for higher rates is pretty straightforward: Car and mortgage loans are secured by the value of your car or home. If you don’t pay them back, the bank can repossess your car or your home, sell it, and recoup some of the money.

However, if you don’t repay a personal loan or credit card, there isn’t any collateral for the bank to repossess to recoup some of the losses. Thus, an unsecured personal loan is much riskier for lending partners than secured loans, which is why they carry higher interest rates.

Of course, a comparatively higher interest rate doesn’t make a personal loan a bad deal. Many people use personal loans to refinance high-interest credit card debt, or to finance a major purchase or expense in a less-expensive way. Below, we calculated how much you can save by financing a £5,000 balance on a credit card at 20% or using a 3-year personal loan at a lower APR.

Credit card APR Personal loan APR Interest saved over 3 years
18% 6% £1,031
18% 8% £867
18% 10% £699
18% 12% £529

As you can see, personal loans can save you a relative fortune in interest compared to the typical credit card, even on a relatively small balance of £5,000. The advantage of a lower APR is that more of your payment goes toward paying down your debt, which means you’ll make more progress toward being debt-free every single month.

Here are few things you should know before you start shopping for an online personal loan:

How to get a personal loan with bad credit

Because personal loans aren’t backed by any collateral, credit scores play an important role in whether or not a bank will approve you for a loan. Having bad credit will make it more difficult to get approved, but not impossible.

Here are a few tips and tricks that can make it easier for you to get a personal loan, even if your credit is far from perfect.

Is a personal loan right for you?

We put together a short decision tree to help you decide if a personal loan is right for your situation. If all of the following statements apply to you, then a personal loan could be the best way to borrow money for your financial needs.

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