A personal loan is typically issued for a specific amount and can be used for various purposes at the discretion of the borrower. This kind of loan is used for everything from funding an education or financing a new business venture to purchasing luxury items or taking a lavish vacation.
A personal loan can be a secured loan or an unsecured loan. A secured loan uses an asset — such as a house or car — as collateral (or support). If the borrower defaults on the loan, the creditor can take the asset. An unsecured loan does not require collateral and is considered high risk. As such, it has a higher interest rate.
Personal loans have evolved over the years, to meet the changing needs of the consumer. Whereas it used to be nearly impossible to get a personal loan with a limited or bad credit history, today there are loan options for nearly every consumer.
Personal Loan Knowledge
It is important to be familiar with loan terminology when entering into an agreement with a lender to ensure a solid understanding of the information being presented. Below are some financing terms that are commonly used in the personal loan arena :
- Credit history: a record of how a consumer has borrowed and repaid debt.
- Lender: the entity that makes funds available for borrowing.
- Debt: money that is owed from a borrower to a lender.
- Asset: an item of ownership that has exchange value.
- Collateral: the pledge of an asset to a lender to secure repayment of a loan.
- Fair Market Value (FMV): the amount something would sell for in the open market.
- Term: period of time between the initial procurement of the loan and the time the loan is to be paid back in full.
- Equity: the difference between the fair market value and the level of indebtedness.
- Home equity: the difference between the market value of a home and the outstanding mortgage balance.
- Home equity line of credit (HELOC): a type of secondary financing that consists of a revolving line of credit.
- Home equity loan: a type of secondary financing that consists of a single loan amount.
- Interest: the cost of borrowing money.
- Interest rate: percentage of a loan that will be paid back as interest.
Types of Personal Loans
The changes in the economy over recent years have prompted lenders to restructure their standard lending practices, offering a wider array of personal loans to meet the average consumer’s financial needs.
Each type of loan has advantages and disadvantages. Choosing the right type of loan depends on the individual and his or her lifestyle. Borrowers should consider the importance of the desired loan versus current credit standing.
The seven most common types of personal loans are:
Home Equity Personal Loan: finite amount secured by the equity in your home
PROS
|
CONS
|
+ lower interest rate
|
-must put up home as collateral
against loan
|
+ larger borrowing amounts
|
|
+longer payment terms with lower
monthly payments
|
- Home Equity Line of Credit (HELOC): revolving amount taken as needed and secured by the equity in your home
PROS
|
CONS
|
+ only pay interest on amount
borrowed
|
- must put up home as collateral
against loan
|
+ control over how and when you
use the money
|
|
+ monthly payments may be interest
only for a while, making them lower
|
- Short-Term Personal Loan: taken when funds are needed urgently
PROS
|
CONS
|
+ relatively quick and easy to
obtain
|
- higher interest rate because
repayment term is shorter
|
- Fast Cash-Advance (or Payday) Loan: taken when funds are needed immediately
PROS
|
CONS
|
+ quick and easy to qualify
|
- short term (about two weeks)
|
- highest interest rate
|
- Military Payday Loan: specific to men and women in the military
PROS
|
CONS
|
+ flexible repayment schedule
|
- variable interest rate
|
+ credit history carries less
weight
|
- must provide paystubs or proof
of employment
|
- No Credit/Bad Credit Personal Loan: for consumers with a bad or limited credit history
PROS
|
CONS
|
+ credit score has little to no
bearing
|
- high interest rate
|
+ credit check may not be required
|
- Second-Chance Personal Loan: for a financial crisis or personal tragedy
PROS
|
CONS
|
+ option of taking the loan as
secured or unsecured
|
- higher interest rate
|
+ credit history doesn’t hold as
much weight
|
- short term
|
- strict limits on amount that can
be borrowed
|
Taking Out a Personal Loan
The most common sources for obtaining a personal loan are banks and credit unions. Both have positives and negatives, and it’s up to the borrower to decide which option is best.
It’s important to know the difference between a bank and a credit union. A bank is a for-profit corporation owned by private investors, whereas a credit union is a not-for-profit establishment owned by members of the union. While both are governed by a board of directors, a bank’s board is chosen by the stockholders and a credit union’s board is selected by its members.
Although banks have been a more accessible borrowing option in the past because of the large pools of capital they manage, credit unions are growing in popularity among consumers. Recently credit unions have become competitive with banks, offering lower fees and higher levels of service. In addition, membership in credit unions has become much less restrictive, making them available to a larger and more diverse population.
Personal loans can be a great financial resource if their purpose is well thought out. Understanding the types of loans available, the unique features associated with them, and the terms and agreements are paramount in making educated decisions regarding finances.
When considering a personal loan, consumers must know the facts. Borrowers should be familiar with their credit report so they can decide which personal loan is best for their needs, and which types they will qualify for. Also, it’s important to consider future income changes as they relate to the repayment of the loan.
Al Krulick
The most common sources for obtaining a personal loan are banks and credit unions. Both have positives and negatives, and it’s up to the borrower to decide which option is best.
It’s important to know the difference between a bank and a credit union. A bank is a for-profit corporation owned by private investors, whereas a credit union is a not-for-profit establishment owned by members of the union. While both are governed by a board of directors, a bank’s board is chosen by the stockholders and a credit union’s board is selected by its members.
Although banks have been a more accessible borrowing option in the past because of the large pools of capital they manage, credit unions are growing in popularity among consumers. Recently credit unions have become competitive with banks, offering lower fees and higher levels of service. In addition, membership in credit unions has become much less restrictive, making them available to a larger and more diverse population.
Personal loans can be a great financial resource if their purpose is well thought out. Understanding the types of loans available, the unique features associated with them, and the terms and agreements are paramount in making educated decisions regarding finances.
When considering a personal loan, consumers must know the facts. Borrowers should be familiar with their credit report so they can decide which personal loan is best for their needs, and which types they will qualify for. Also, it’s important to consider future income changes as they relate to the repayment of the loan.
Al Krulick