Financial Education

Personal loan: what is it and how does it work?

Personal loans are financial resources that can be strong allies to fulfill dreams or in emergency. However, you need to know how to use them. So, read on to understand how they work!

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Things to keep in mind when considering a personal loan

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Money to accomplish what you want: understand a personal loan and its main advantages and disadvantages. Source: Flicker

In fact, knowing what a personal loan is and how it works is the first step to benefiting from this tool.

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Next, we will explain everything you need to know to take out a personal loan without causing problems in your financial life. Read on!

What is a personal loan?

In effect, a personal loan is a cash loan from a bank or credit agency to an individual. An interest rate is set, and the loan amount is usually paid monthly.

In most cases, payments start as soon as the applicant receives the loan money. Thus, the loan amount is usually paid by bank transfer. However, it is possible to receive it as a check.

Typically, in the US, this type of loan is unsecured. That is, you do not need to offer houses, cars, or any other asset as a guarantee of payment.

However, in the market, some credit companies work on these terms. Below, understand more about what a personal loan is, knowing the main terms and rates of this type of loan!

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Terms

Loan amounts are the total money that is available to you. Theoretically, the amount available for this type of loan is up to $100,000. However, only people with excellent credit are eligible for loans over $40,000.

Therefore, loan terms are the time you have to pay off your entire loan. Generally, the maximum term for personal loans is up to 84 months.

Fees

Learn about the main fees related to personal loans below!

Interest rate (APR)

In fact, this fee is the most important of a loan. This is what guarantees the profit of white people and credit agencies. The interest rate is a calculated percentage of the total loan amount.

This amount is then “diluted” into the monthly fees paid, most often monthly. It is possible to find fixed rates, constant throughout the loan.

There is also loan in variable rates, which fluctuate according to the Prime rate, for example. Typically, this rate is between 5% and 36%.

Origination fee

This is another fee generated in connection with offering the loan service. In turn, it is a one-time fee. In fact, many lenders do not charge it.

However, some banks still use it for up to 6% of the total loan amount.

Late fee

Fixed amount or percentage rate charged each time you are late paying a monthly loan payment for a certain period of time.

They usually cost anywhere from $25 to $50 or between 3% and 5% of the installment amount.

Early Payoff Penalty

Fee charged if you want to advance the payment of one or more installments. Most banks and credit bureaus no longer charge this fee these days.

However, you should ask your lender if you plan to take a down payment.

What can you use a personal loan for?

Unlike student loans and other modalities, personal loans do not have a specific purpose. Then, once you have the money in hand, you can use it however you like.

However, it is common to indicate the reason why you want the money when requesting this service from a bank. Thus, you can request amounts to pay:

  • Medical emergencies;
  • Home or car repairs;
  • Holiday travel;
  • Wedding party;
  • Purchases of considerable value;
  • Payment or consolidation of debts;
  • Or for any other reason.

Does applying for a personal loan affect your credit score?

Credit report sheet below a calculator and pen
How does a loan affect your credit? Source: Flickr

Indeed, most companies that offer a loan service check your credit. Therefore, expecting your credit score to drop a little shortly after requesting this service is normal.

This impact can be greater if you apply for more than one loan in a short period of time. Also, monthly payments will increase your total debts.

Therefore, your score is expected to be slightly lower than expected over the “life” of the loan. However, most creditors also report their payments to major credit bureaus.

So, if you make your payments on time, you can recover the initial impact on your credit in a few months. In addition, payments on time can also minimize the effects of your credit in the medium term.

Finally, if you need to take out more than one loan, respect the minimum space of six months between applying for each of these. This will prevent further damage to your credit.

Should you get a personal loan?

In fact, only you know your current financial situation to know whether or not you really need a personal loan.

However, consider the following advantages and disadvantages before making this decision:

Benefits

  • Easy and fast money for any need;
  • Possibility to build your credit;
  • Lower fees than those offered for credit card purchases, for example;
  • Not precious offers goods as collateral;
  • Opportunity to consolidate debts and pay less interest.

Risks

  • If you don’t have a credit score above 720, you may be subject to high-interest rates;
  • Other fees related to your loan can be quite high;
  • Late payments can seriously damage your credit;
  • Monthly payments on your loan can take a huge toll on your budget;
  • In some cases, you may be incurring unnecessary expenses.

How to apply for a personal loan?

Find out four easy tips on how to apply for a personal loan!

Look for the best opportunities

In a quick google search, you can find hundreds of lenders. Also, you can contact your bank. Then, analyze and compare each opportunity.

To speed up your searches, you can count on free services that can filter good opportunities that fit your profile. Check out one of them below:

Apply

After choosing the best option, your application must be formalized. At this stage, you must present your documents and do not forget to read the conditions of your loan in detail.

Wait for approval

The lender may take some time to decide on your loan. However, you will get an answer within hours or a few days.

Receive the funds

After approval, you must inform the account into which the money should be deposited. On average, the deposit should be available to you within a maximum of three days.

Alternatives to taking out a personal loan

Dollar eyes (what is a personal loan)
Far beyond loans: discover other ways to get money without compromising your budget. Source: Pixabay

Credit card with a 0% APR period

You may be eligible for a card with a good credit limit that does not charge interest. In fact, this is the best way to get a loan.

However, only people with good or excellent credit (above 690) can use this feature.

Credit line

These services are offered by credit unions or banks. They are a hybrid between a loan and a credit card.

You can withdraw only the amount you need and pay interest on the amount you use. This way, it becomes much easier to manage your finances.

Now that you know more about how personal loans work, you can read our post below to learn about how to choose the best bank for your finances!

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About the author  /  José Gonçalo

I started reading about finance only to find better options than savings. Since then, I have never stopped studying finance, and I believe that writing about it is the best way to help individuals feel fulfilled and have a healthy financial life. Today, I balance finance and medical school studies.

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