What Exactly Is a Personal Loan?
A personal loan is unique in that it is normally an unsecured debt. This means that there are no collateral issues that you may face as compared to other loan types.
For example, if you have an automobile loan, the bank, or other lending institution that puts up the money for the loan, has the right to take the car into possession if you don’t make payments. With a personal loan, there isn’t collateral put up, so it’s likely that it will take a higher credit score will be required to qualify for one.
Personal loans are also essentially installment loans. Installment loans have a fixed repayment schedule, over the course of a couple years, typically, and will quite often have a fixed interest rate. With a credit card, there are fluctuating amounts of debt, depending on the amounts you have been spending, and of course, payments will go up and down due to interest rates and the amount owed.
While there are such things as secured loans, they tend to be a bit more uncommon. Occasionally, you will see a loan taken out that is backed by a savings account or some other type of asset.
If you default on the loan, the bank or lending institution will have the right to take that collateral in order to recoup some of the losses. With this in mind, the unsecured loan is by far much more common.
Credit Score is Crucial
When taking out a personal loan, your credit score is crucial. The credit score will be scrutinized quite closely, as well as any credit history, beyond just the numbers. This is because the lending institution understands that the loan could go bad, and at that point, there is no easy recourse.
Ultimately, this makes the lenders a bit cautious, therefore forcing them to place a lot of emphasis on your credit score. As a general rule of thumb, the higher your credit score, the better off you will be as far as interest rate is concerned. This of course greatly impacts what the monthly payments will be.
For example, if you have a credit score of 725, you are much more likely to find an affordable loan than if you had a score of 500 - which coincidentally, will probably make a personal loan all but impossible anyway. If you do get a personal loan, it’s very likely that the interest rate will be close to credit card levels.
Interest rates can vary drastically, so make sure you compare personal loan rates. However, if the interest rate is extraordinarily low, it could signal that perhaps there are other fees involved. Make sure to read through the term documents thoroughly to ensure that you fully understand if there are any extra fees or requirements.
You Can Be Sued
Unlike a secured loan, such as a mortgage, if you default on a personal loan, the lender may take you to court to sue you. This can result in extra fees, and possibly even legal fees.
Remember that you also have the possibility of running into prepayment penalties as well, so keep this in mind. Bottom line, you should be sure that the monthly payments are easy to accomplish and that you pay them accordingly. If you realize that you can't make a payment, know that you can try to work with your bank or lender to defer a payment.
Credit Unions Are an Excellent Alternative, At Times
If you have a low credit score, you may find better terms at your local credit union, as they often cater for this type of client. They usually have programs to help re-establish credit more often than the traditional banks, so you should look into these institutions and their offerings.
Applying Impacts Your Credit Score
When you apply for a personal loan, the lender will pull your credit history as part of the application process. This is what is known as a “hard inquiry” and will cost you a couple of points to your credit score. While not catastrophic, it’s shows up as a bit of a ‘ding’ on your report. These couple of points and the credit inquiry will be on your report for the short term, but as long as you don’t have too many of these, it should be a small bump in the road.
The Take Away
Personal loans are another way to bring in extra money for some type of debt you may find yourself in, or perhaps to bridge some gap in your financial life. However, just as with any other loan, there are up and down sides and important things to pay attention to. Unfortunately, far too many people need the money badly enough to ignore a lot of the potential pitfalls. You should make sure that you can repay the loan quite easily, and that the installments are affordable. Keep in mind that the loan tends to run over the course of a couple of years, so caution is advised.