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By Katie Levene
Personal loans are convenient affordable options for many people. Learning about how personal loans work can help you choose a loan that's right for you. To help you make your choice, let’s demystify personal loans by answering common questions about them.
A personal loan works very similarly to any other loan. Borrowers get the loan amount in a lump sum, and they typically make monthly payments to pay off their debt.
Personal loans come with a variety of terms and interest rates depending on your needs. “Term” is the amount time you have to pay back the loan; “interest rate” is the amount a lender charges you and is a percentage of the amount loaned. You could get a personal loan with a term from one to five years at many places and loans can range from as low as $1,000 to $50,000.
The loan amount will depend on how much you apply for and are approved for (if you’re approved). It’s a rule of thumb to only ask for what you need so you don’t pay interest on more than you wanted.
Many lenders offer a decision on your loan application the same day, and if you’re approved, will either write you a check or deposit the cash in your account the same day.
As with everything, you’ll want to shop around to find the personal loan that meets your needs. Pro tip: Look for an online personal loan that does not have a prepayment penalty. Without a prepayment penalty, you’ll be able to pay off your loan early without an extra fee.
There are two types of personal loans: Secured and unsecured. The main difference is in collateral. A secured loan is, well, secured by collateral. With a secured loan, you agree that if you stop making loan payments and default, the lender can take the collateral (like an auto or home loan). Because you are offering collateral, a secured loan will typically be easier to qualify for and will carry a lower interest rate than an unsecured loan.
Personal loans are usually unsecured, meaning no collateral is needed. Applying for a loan is usually simple but it does require running a credit report. A lender will want to ensure you’re a good candidate for the loan and you’re likely to pay the loan back in full.
A credit card is what’s considered revolving debt, meaning that if you charge $100 on a card with a $1,000 limit, and you pay back that $100, you will once again have $1,000 to spend. With a personal loan, known as fixed debt, you receive a $1,000 lump sum, and that’s it.
A personal loan also offers you the ability to have cash, which is better for those times when credit cards are not useful or accepted forms of payment, for example, when hiring a contractor for home repairs.
Some unsecured personal loans may also offer a lower interest rate than a credit card. However, you should watch out for origination fees, which can impact the total cost of the loan.
Personal loans could be used for many things. That includes debt consolidation, emergency expenses, home renovations or even a once-in-a-lifetime vacation. (In general, personal loans cannot be used for things like gambling.) When you apply for a personal loan, you may be asked to specify the purpose of that loan to make sure it conforms to the lender’s requirements.
Personal loans are most helpful when they allow you to consolidate debt at a lower rate, to pay emergency expenses quickly, or to fund a project that could yield a high return, such as a home renovation.
If you are someone who has trouble managing your credit cards, but you need a quick cash injection, a personal loan may be the right option, since your debt load cannot grow. If you need more time to pay off a purchase and a personal loan offers a lower interest rate than your credit card, it makes fiscal sense to opt for the loan.
Applying for an unsecured loan can be a simple process, similar to a credit card. For example, you can apply for an Alliant unsecured personal loan online, and you could receive same-day approval and even a same-day deposit into your account. However, it’s important to make sure you can afford to repay the loan on time every month.
Consolidating for a lower rate: An online personal loan could be for you if you’re paying off high-interest debt and you’d like to simplify your payments at a lower rate. Consolidating debt, such as credit card debt, into one low payment can help you evaluate how much debt you have because your debt is in one place. You can also then come up with a payment plan more easily and even create a plan to pay off your loan early.
Simplifying payments could give you some peace of mind and could reduce the likelihood that you miss a payment. Plus, with automatic payments, you can set it and forget it!
Paying for emergency expenses: The saying goes, “life happens when you least expect it.” Ideally, you would pay for sudden expenses with an emergency fund. However, most Americans don’t have more than $1,000 in an emergency savings account. So, when something unexpected happens, such as a pricey hospital visit or a major leak in your roof, an online personal loan could help. Many lenders will give you a decision on your loan and deposit the money into your account the same day you apply. In other words, a personal loan is great when you need cash fast.
Funding a project with potential return: Whether it’s an investment in your home or yourself, a loan could open opportunities for growth. A personal loan can help fund a home improvement project with a big return. It could also help you pay for a certification that could help further your career. If you don’t have the funds to start a project today but believe there will be a return on your investment, a personal loan may be able to help.
When you apply for a personal loan or any other type of loan, the lender will consider your credit score and credit history, your income, and other factors. Some lenders perform a hard credit check that stays on your credit report for about two years when you apply. While it's on your record, it could lower your score by a few points. Other lenders perform a soft inquiry or soft credit pull, which do not have any impact on your credit score.
Making late payments or defaulting on your loan could also lower your credit score. If you make your payments on time, you could raise your score instead.
Your credit score could impact your personal loan rate and monthly payments. Before applying, ensure your credit score is correct by reviewing your credit report. You are entitled to free copies of your credit report from Experian, TransUnion, and Equifax (the credit bureaus) every 12 months. You can request a copy from AnnualCreditReport.com. If there are any errors, you can dispute them.
When you apply for a personal loan, be prepared to provide financial documents like your most current tax returns and bank statements. The lender will send you the terms of the loan after they approve your application. Make sure you read the contract carefully and only agree to the terms if you can afford the payments.
Alliant members can receive a competitive rate on a personal loan. Alliant’s quick, affordable personal loans could give you the cash you need, when you need it. Apply today!
Check out these other useful loan tips:
Katie Levene is a marketer fascinated with finance. Whether the topic is about the psychology of money, investment strategies or simply how to spend better, Katie enjoys diving in and sharing all the details with family, friends and Money Mentor readers. Money management needs to be simplified and Katie hopes she accomplishes that for our readers. The saying goes, "Knowledge is Power", and she hopes you feel empowered after reading Money Mentor.
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