What is a personal loan?
As the old saying goes, you have to spend money to make money. A renovation might increase the value of your home, but most homeowners don’t have the cash on hand to pay for such a project. Maybe you’re a small business owner and some top-of-the-line equipment would boost your bottom line, but paying for it seems impossible.
In situations like these, applying for a personal loan might be your best option. While some forms of credit are used for specific purposes, personal loans offer a more flexible financial resource for anyone looking to make a large purchase, pay for an unexpected expense or better organize their finances.
What is a personal loan?
A personal loan provides financing for borrowers looking to make a large purchase or consolidate their debts. These funds are usually handed over in one lump sum and repaid through installments over time.
Unlike mortgages or student loans, personal loans can be used for a variety of purposes. This flexibility allows borrowers to pay for a wide range of expenses, such as medical bills or home expansions.
While personal loans can be taken out to settle existing debts or make a large purchase, the most savvy borrowers will use these loans to add value to an existing asset. For example, a personal loan can be used for renovations, giving the property a boost in value and increasing your level of equity in the home.
When applying for a personal loan, you’ll request a specific amount from a lender. The lender will decide whether to issue you a personal loan based on all the usual factors, such a review of your credit report, debt history and available finances. If you’re uncertain about your eligibility for a personal loan, you have the option of seeking preapproval before you apply.
While the preapproval process is a requirement for mortgage loans, it’s an optional but beneficial step for personal loan applicants. Preapproval allows you to shop around for a loan, check the rates of multiple lenders and gain a clear picture of your own borrowing limits and projected payment plan.
Preapproval for a personal loan also helps you understand what type of loan suits you best as well as how much you’ll pay in interest over time. Depending on your financing needs and eligibility, the amount you pay in interest can vary. Before sending in an application, you should thoroughly understand the differences between secured and unsecured loans and which one suits your financial goals.
Interest rates on a personal loans
The interest rate of a personal loan depends heavily on what type of lending structure you and your lender decide. Once you’re preapproved and have a clear picture of your borrowing eligibility, you’ll either apply for a secured or unsecured personal loan. While most personal loans are unsecured, under some circumstances, a lender might be more willing to approve a secured loan.
Let’s explore both types and see how each of their requirements might suit your financial needs.
Unsecured loans
For many loans, you’ll need to offer up some type of asset or personal property to get the loan approved. After approval, the lender places a lien on that property, giving them the right to repossess the asset if monthly payments are missed. This is known as collateral, and is commonly used as a method to secure financing.
Unsecured loans, however, do not require collateral. Lenders make their decision to approve an unsecured loan based on the applicant’s credit score and history of debt management. If you’ve managed to avoid financial issues with credit cards or debt management in the past, you’ll have a much better chance of being approved for an unsecured loan.
Since collateral is not a requirement for unsecured loans, lenders aren’t able to recoup their losses if you default on your payments. To make up for this additional risk, lenders will attach higher interest rates to unsecured loans as a means of assuring a return on their investment.
Secured loans
If you have a history of credit trouble or problems with other debts, lenders might only approve a secured personal loan rather than unsecured. A low credit score means lenders view you as a higher risk. While you might have every intention of repaying the loan in a timely manner, they’ll want some extra assurance that they're making a safe investment.
Therefore, secured loans require some form of collateral by the borrower. Usually the borrower’s car or property, this collateral backs up the loan and can be claimed by the lender in the event of a loan default.
Since secured loans are backed up by collateral, lenders won’t attach a higher interest rate to make up for risk. Generally, a secured personal loan’s interest rate will be lower than one that is unsecured.
What is the benefit of obtaining a personal loan?
Other forms of credit, such as mortgages and student loans, require you to use the funds for a very specific purpose. A major benefit of a personal loan is its usefulness for a variety of scenarios.
This flexibility makes applying for this type of , Here are two of the major uses borrowers have for
Personal loans and large expenses
Personal loans provide an excellent option for borrowers facing a sudden and unexpected need for financing.
Property damage and litigation issues might be partially covered by your homeowners insurance plan, but can remain costly even after your policy holder steps in. Unexpected costs like medical bills can also be covered by a personal loan.
Many borrowers use this financing tool to add value to an existing asset. Personal loans can be taken out to fund property renovations, or to buy new equipment or services that will benefit your business.
Personal loans and consolidating debts
High interest credit card debts are not only a strain on your bank account, but keeping track of multiple monthly payments can be a time-consuming and exhausting process. If you’re having difficulty managing numerous repayment plans, combining all of your debts into one is possible through a personal loan.
By taking out a personal loan to consolidate your debts, the lender provides a lump sum that settles the debt with your creditors. Since all of your creditors have now been paid back in full, you’ll only have to focus on a single payment structure with your lender.
Solving a debt problem by taking out an additional loan might seem counterintuitive, but by consolidating several of your debts into one monthly, low-interest payment can simplify your finances and streamline debt repayment.
In conclusion
Whether you’re looking to further invest in an asset, consolidate debts or pay for major unexpected expenses, taking out a personal loan provides a flexible financing option to help you achieve your goals.
Before applying, consider seeking preapproval and getting a good understanding of your borrowing capacity and what type of personal loan works best for you.