What is a Personal Loan?
Strictly speaking, any loan that the borrower will pay back with personal assets like her salary can be considered a personal loan. However, the term is normally applied only to unsecured cash loans. Personal loans may also be called consumer loans or signature loans. Personal loans are available from banks and credit unions. There are many finance companies that specialize in personal loans. "Payday loans" are another example of this type of brrowing.
Characteristics of Personal Loans
Lenders usually do not require collateral for personal loans. This is in sharp contrast to loans made to buy a house or car. A home loan or auto loan is secured, which means the lender can take the property if a borrower defaults on the debt. Borrowers are also free to use cash raised by taking out personal loans for any purpose. With a secured loan, the borrower is often obligated to use the money for a specific purpose.
Lenders check credit histories and credit scores before approving personal loans. Credit information is used to determine if the lender will extend credit to a potential borrower. In addition, lenders use credit reports to set interest rates. Because there is no collateral to reduce risk, interest rates may be high. Equifax says interest rates on personal loans are similar to what consumers pay on credit card balances. However, some personal loans may carry interest rates as high as 35 percent.
Things to Consider When Making Personal Loans
Many financial institutions offer personal loans. Some charge lower interest rates than other. Some lenders offer personal loans with terms that are more favorable to consumers than others. Before an individual takes out a personal loan, her or she should always shop around to find the best deal. Here are some things consumers should keep in mind:
1. Consumers should be sure they know the total cost of the loan. Lenders often charge various fees in addition to interest.
2. Paying off personal loans early will reduce total interest cost. However, some lenders charge penalty fees when a loan is paid off early.
3. Credit unions can sometimes offer lower interest rates on personal loans because they are nonprofit financial institutions. In addition, credit unions may have special programs for people with weak credit histories.
4. The fact that personal loans are unsecured does not mean there are no adverse consequences for non-payment. A defaulted loan still hurts a consumer's credit rating. Lenders can also sue borrowers who fail to repay loans.
Because interest rates on personal loans are often high, consumers may want to keep this option in reserve for times when quick cash is urgently needed. Paying these loans off in a short time helps to reduce interest costs.