How Do Personal Loans Work? A Beginner’s Guide

Personal Loan

If you need cash right away, a personal loan can help you get back on your feet. If you are approved for a personal loan, you’ll be advanced a loan amount, which you’ll be able to use at your discretion.

A personal loan is a financial commitment, so it’s important that you know exactly what you’re signing up for and have a reasonable repayment plan in place before taking out a personal loan. Here’s a beginner’s guide to what you need to know about personal loans

Types of personal loans

There are different types of personal loans that are designed to help people in various financial situations. The loan offer and loan terms will vary based on the type of loan you take out.

Credit cards

A credit card is a personal loan that offers a line of credit that you’ll have to repay each month. A credit card is a great way to build your credit history and earn cash-back rewards for making routine purchases.

Credit cards can be a smart financial decision, but they pack high interest rates. If you miss a monthly payment, expect to pay upwards of 10% interest on your borrowed money.

Debt consolidation

If you have multiple sources of debt, it can be expensive and a hassle to make your monthly payments. When you consolidate your debt, you’ll only have to make one debt payment each month, often at a lower interest rate than those of your previous debts.

At T&I Credit Union, qualified borrowers can borrow up to $10,000 for an up-to 48-month repayment term.

Life loans

If you need to finance a major life event, like a wedding or holiday, you can take out a life loan. These loans have relatively short repayment terms.

Student loans

With this loan, a financial institution will advance you the amount of money in your savings account. This is a great way for people with bad credit to qualify for a loan and improve their credit score. Your savings account secures the loan amount, making this a low-risk loan for lenders.

Signature loans

A signature loan is the most basic of personal loans. You ask a lender for money and promise to pay it back with your signature. What you do with your loan is completely up to you.

These loans come with high interest rates, and because this is an unsecured loan, you’ll need to have some credit-worthiness to qualify for the loan.

Applying for a personal loan

Traditional financial institutions, like banks and credit unions, offer personal loans. Now, you can also get a personal loan from online lenders and peer-to-peer lenders. Although non-traditional lenders may make it easier to take out a loan, they may charge higher interest rates, and they often don’t provide the additional financial products and services that traditional financial institutions specialize in.

You can quickly apply for a loan online. You’ll have to supply relevant information about your financial history to qualify for a personal loan.

Know the loan terms

Before you sign a loan agreement, make sure you know the terms of the deal. Ask an associate at the financial institution about any parts of the agreement you don’t understand, and be sure you know how the loan will need to be repaid.

Most personal loans are offered with fixed rates, meaning the interest you pay on your loan is agreed upon when you sign your loan, and it will remain the same throughout the duration of the repayment period.

Some lenders offer loans with variable interest rates, meaning the amount you pay on your loan can change each year. This is a riskier loan to take out, as the price of your loan could go up in certain economic scenarios.

Know the cost of the loan

A loan costs money; if you take out a loan to fund your wedding, for instance, you’ll end up paying for the cost of your wedding in addition to the cost of the loan.

The interest rate you pay on your loan is the loan price. To determine the cost of your loan, divide the APR by 100 and multiply this number by the loan amount. For example, if you pay a 4% APR on a $10,000 loan, your loan will cost $400. You’ll be responsible for paying your lender $10,400 over the course of the loan term.

Beware of additional fees associated with taking out a loan. To take out some loans, you might have to pay an application fee or an origination fee. If you want to pay a loan back before the loan term expires, you might have to pay a prepayment penalty. Make sure you know the total cost of your loan before you sign the agreement.

Taking out a loan to pay your expenses is more expensive than using your savings to settle your accounts. For this reason, it’s best to stay out of debt, when you can. If you find yourself in a situation where you need additional funds, quickly, shop around for a favorable loan so you don’t pay more than you need to.

Getting a favorable interest rate on your personal loan

Finding a loan with a relatively low interest rate is one of the best ways to keep your costs down. Do your research on the nearby financial institutions to find an affordable option.

Credit Unions, as not-for-profit institutions, can often offer more affordable interest rates than banks.

Your lender will offer you an interest rate based on your credit-worthiness. When a lender advances you money, there’s a chance you’ll default on your loan, and the lender will suffer a loss. How likely you are to repay your loan affects how much risk the lender undertakes when offering you a loan. The more risk involved in offering the loan, the more reward the lender will expect.

This is why people with bad credit tend to have to pay higher interest rates; your credit score is a measure of your credit-worthiness, and the interest is the lenders’ reward for offering the loan.

Increase your credit-worthiness

The price of your loan is negatively related to your risk as a borrower, so the best way to decrease the total amount you pay is to increase your credit-worthiness.

Most lenders will use your credit score as the largest determinant for your interest rate. Your credit score is decided by how well you’ve repaid debts in the past and your current balance of debts to income and other assets. It takes time to improve your credit score, so if you need money soon, you’ll have to find other ways to increase your credit-worthiness.

You can leverage your equity in your home, car, or savings account to decrease the risk associated with giving you a loan. When you leverage your assets for a loan, you can take out a secured loan. With a secured loan, the financial institution can seize the asset you stake for the loan if you default.

If you’re a student, or you don’t have a good credit history or assets for other reasons, you can piggyback on the good credit of someone else to get a lower interest rate. When you co-sign on a loan, you’ll both be held accountable to repay the loan amount. This means if you default, your co-signer will have to pay back the loan amount and interest. Be careful with this tool, as lost friendship may be more costly than a high interest rate.

Choose T&I Credit Union

If you need a personal loan to finance your school, fund a life event, or settle your accounts, consider taking out a loan with T&I Credit Union. We offer competitive interest rates and other financial services so you can make the most of your money and move toward financial security. Contact us to learn more.

About Annie Marrian

Annie Marrian is a writer and former educator who studied economics at a major Catholic institution in the Northern United States. In her free time, she enjoys driving through neighborhoods and collecting For-Sale brochures.

Leave a Comment

Your email address will not be published. Required fields are marked *