Personal loans are a common way to receive money, but how do personal loans work? This guide explains personal loans as well as when they are a good idea.
The world of personal loans can be a bit intimidating, but you need to learn, or else you could end up worse off financially than you are now.
Getting a personal loan isn’t easy. If you’ve ever walked into a bank and talked about them with a financial advisor, then you probably know how much paperwork and back-checking is involved with applying for one. Unless you’re already financially stable, there’s a good chance you’re going to have your application denied.
Today, we’re going to help you answer the question, “how do personal loans work?” and give you some guidance for what to expect from this process. The world of personal loans, especially bad credit loans, can get a bit dicey. You need to have your wits about you so you don’t get taken advantage of.
How Do Personal Loans Work?
Everyone could use a little bit of extra cash sometimes. In certain situations, like purchasing a house or consolidating debt, you might need a bit more than “extra cash”. In either situation, you’ll more than likely try to get a personal loan to fund these needs.
Why a personal loan over a credit card?
Credit cards certainly offer some perks, but when you need a larger amount of money at one time, the variable interest rates and fluctuating monthly payments make them more expensive than they’re worth. If you need a bit of money to get over a financial hurdle, then a credit card might be a good idea.
Personal loans are better than credit cards because you get a predetermined amount of money with a fixed interest rate and repayment period. This gives you the luxury of having the same payment amount every month, which really helps for budgeting.
Depending on your credit score, personal loans generally have lower interest rates than credit cards; around 4% APR on a personal loan for someone with excellent credit versus 17% APR on a credit card for someone with average credit.
Secured Vs. Unsecured Loans
There are two types of personal loans that you’ll see available: secured and unsecured. When you hear people discussing personal loans, they’re almost always talking about unsecured loans. An unsecured loan is one that doesn’t require any collateral on the part of the borrower.
Although secured loans require you to put up something (a car, house, etc.) as collateral in the event that you fail to repay the loan, they come with lower interest rates as a result. Whether you want to risk losing something of value is up to you, but most personal loans from banks or private lenders are unsecured.
The Role of Your Credit Score
Your credit score greatly impacts the terms of your loan, the interest rate, and whether or not you’ll even be approved for the loan. When you have a great credit score, then you’ll be able to take out a large personal loan with great repayment terms.
If your credit is bad or non-existent, then the chances of you getting approved for a personal loan from a bank is low. Fortunately, there are numerous resources that provide bad credit loans to those in need. You need to be careful and do your due diligence before accepting one of these, however.
Getting a Loan With Bad Credit
Getting a bad credit loan is often a much easier process than getting a personal loan from a bank. There’s less paperwork, they might not even look into your credit score, and you could get paid before the end of the business day. That doesn’t mean that it’s necessarily going to be a good option for you, though.
The thing about bad credit loans is that the interest rate is almost always very high compared to normal personal loans. For that reason, you should only apply for one if you’re confident that you can pay back the borrowed amount in the agreed-upon timeframe.
When you don’t, you end up doing more harm than good for your finances and your credit score. This makes it even harder to climb out of debt and improve your credit, forcing you to go further into the cycle of borrowing from less-than-desirable lenders.
That being said, there are bad credit lenders out there that aim to help you get out of this debt cycle by providing better loan terms and flexibility, as well as educational resources to help people understand their finances.
Getting Out of Trouble and Avoiding Debt
If you want to get out of the debt cycle and build up your credit so you can satisfy personal loan requirements in the future, then borrowing money is a good start. When you borrow from lenders that report to the big credit bureaus, then how you pay back the loan will be reflected in your credit score.
Apply for credit cards and smaller personal loans whenever you need extra money and be diligent about your monthly payments. You might even be able to pay off your personal loan before the terms laid out in the agreement, but some lenders will penalize you for this, so it’s important to check before doing so.
The more positive lending experiences you get on your credit report, the higher your score will get. Eventually, you’ll be able to apply for unsecured loans at the bank and get those desirable loan terms and interest rates that we spoke about earlier. It might take a while, but it’s worth fighting for in the long-run.
It’s a Learning Process
Asking the question, “how do personal loans work?”, is a great first step in learning more about your personal finance and how you can take control of it. It’s a long process that can take many years, but knowing what personal loans are good and which ones you should avoid is a perfect way to start.
To learn more about personal finance, business, and lending, come back and visit us again soon.