A personal loan is one of the most common types of loan issued by banks and other lenders, and is also one of the easiest to understand. The lender will issue a principal amount, which you must pay back over several installments with added interest. These installments are usually of equal amounts and scheduled on a monthly basis. As the name suggests, personal loans are personal, i.e. they are intended for personal use (not typically to start a business) and you are not usually required to divulge the reason behind applying for one. Most citizens with a fair credit score and a source of income will have access to personal loan products from multiple lenders.
If you are considering applying for a personal loan, here is a more detailed overview of what you can expect:
What Can I Use It For?
In theory, anything. A personal loan is a general purpose loan that you are free to use any way you desire. There are no conditions attached and the lender will not ask you outright what you need it for, unlike a business loan or a mortgage which is design specifically to buy a home. You may wish to make a material purchase, consolidate other debt, improve your home, cover unforeseen expenses, and so on.
How Much Can I Borrow?
Personal loans are intended for individuals who need to make a large purchase but do not have the finances upfront. The process of paying back the loan can therefore be envisaged as saving up for something in reverse. You already have the item or covered what you needed to, but now it’s time to pay for it. The average personal loan amount issued in 2015 according to TransUnion was just over £7,000. Some people however will wish to borrow below £1,000 and others might even push it to the tens of thousands. The exact amount you will be offered by lenders will depend on your income status, employment, credit score and various other factors. Typically however most lenders will not enter the $100,000 mark without requiring collateral. Particularly expensive items like luxury cars or real estate have their own unique loan products. You would not use a personal loan for these.
Do I Need Collateral?
No, personal loans are generally known as unsecured loans and do not require you to pledge any asset as backup in case you default. As long as you wish to borrow a realistic amount and do not have a particularly poor credit history, most lenders will approve you for such a loan after an assessment of your personal details and current finances. Only large loans or amounts they deem a risk will require collateral.
What about Interest?
Interest on personal loans is very easy to understand as it’s fixed across the full term and the monthly and overall amount you will need to pay will be presented clearly to you right at the start. Simply put, a personal loan of £8,000 with an Annual Percentage Rate of 10%, will cost you $800 in interest a year. Interest is determined by your creditworthiness (the better your score the better the rate), the length you wish to borrow for (the short the term the higher the rate), and various other internal lender policies.
Is My Credit Score Affected?
Yes, like most forms of credit taking out a personal loan will have an impact on your credit score. The act of applying will record a search informing other lenders that you have been seeking credit, and once you get the cash this will be added to your total amount of debt (which is only an issue if you already have a lot of debt). The good news is that if you make all of your payments your credit score is likely to improve, as this shows you are a reliable borrower.
What’s The Difference from a Credit Card?
Credit cards are a revolving line of credit that you can draw from time and time again, with no fixed payment term and sometimes a variable interest rate. Once you have paid off one of your instalments on a personal loan you cannot go back and draw from that amount again. When you have paid off all the instalments, you no longer have any access to the product. Credit cards are ideal for varied smaller day to day use, whereas a personal loan is more suited for focusing on one particular large purchase.
Can I Consolidate Debts?
As long as you are meeting the obligations of other debts, using a personal loan to consolidate them for easier management and to reduce interest is a great way to get back on top of your finances.