What Is A Personal Loan & How Do They Work?

Need money to pay this month’s rent or car payment? Stuck living paycheck to paycheck? We all get stuck and need money sometimes and one option is taking out a personal loan.

Finder reports that borrowers applied for loans most often to get a car (31%), pay bills (26%), cover emergency costs (21%), pay tuition fees (21%), and consolidate debt (15%).

But not all personal loans are created equal and going into or increasing your debt should be taken seriously. Before taking out a personal loan it’s important to understand how they work.

how do personal loans work

What Is A Personal Loan?

A personal loan is a form of lending when a person or a company delivers money to an individual borrower. When you obtain the loan, you receive a fixed amount of money and have to return it within a predetermined period. As you pay back the money you will have to pay interest, like a service fee, for using the money. Plus, there may be other fees that depend on each lender. Finally, these loans often come without collateral.

But it’s important to be cautious because there are many scams and loan sharks who will try to loan you money at extremely high interest rates (10%+).

How Do Personal Loans Work?

The loan’s life cycle starts when a borrower sends an application. For this, you should check your eligibility and prepare all the required documents. The lender can accept this application and send the money directly or ask for extra documents and proofs.

It costs money to borrow money. How much interest you pay is dependent on many factors, including how much money you borrow, when you plan to pay it back and what credit score you have. Borrowers with a perfect credit score from 700 to 850 can often take out the most amount of money and get the best personal loan interest rate.

Finally, when you got the full sum, the repayment period starts. After returning the entire amount plus interest, the loan is closed. Many lenders also offer re-loaning options with better conditions for clients.

Are There Different Types of Personal Loans?

There are several types of loans and, respectively, several ways to classify them. Let’s check the most popular categories for personal loans:

Short-term vs. Long-term Personal Loans

You can select from several term lengths: Short-term loans from a few days to 1 year, medium-term loans from 1 to 5 years, and long-term loans up to decades.

Secured vs. Unsecured Personal Loans

Secured loans require a specific asset like car or house, while unsecured loans come without any collateral requirements.

Different Personal Loan Lenders

You can apply for personal loans from banks, from governmental bodies, from private financial companies, and from other people through P2P networks.

Steps to Getting a Personal Loan

Okay, now, let’s talk about the process of getting a loan. It’s not difficult to get the money if you know about reliable lenders and meet all eligibility criteria.

Here are the 5 steps to getting a personal loan:

1. Determine the Best Type of Loan for Your Needs

Start with a very simple question: What loan do I need? As you learned, there are several types and each comes with unique conditions and limitations. If you clearly understand the requirements, it will be easy to find the best option.

For example, short-term unsecured loans are the best for covering short term needs like rent, car payments, or any unexpected emergencies if you don’t have an emergency fund.

Wherein, for educational purposes or big purchases, it’s better to choose long offers with low interest.

2. Check Your Eligibility

The next step is to ensure that you meet all requirements and will be able to get a personal loan.

Common Requirements for Personal Loans:

  • You must be at least 18 years old.
  • Credit score. The higher the better but there are also minimal numbers.
  • The majority of companies accept borrowers with a stable job.
  • Alternatively, you may provide other income proofs like investments.
  • Often, companies deliver loans to the country’s citizens only.

3. Prepare Documents and Send the Loan Application

Next, you will need to fill the application form online or in-person. Pay attention to all the fields, provide only real information, and avoid typos. With the application, you should send all the documents requested.

Most likely, the required documents will include:

  • A valid ID. Passport, driver’s license or any other acceptable document.
  • Proof of income. Bank account statements, tax returns, etc.
  • SSN or TN. Work for identification and financial proofs, as well.

Double-check everything before you send it. It’s better to avoid miscommunication to save time, especially if you need the money quickly.

Also, note that some companies are pre-approving applications, which means a borrower will need to send additional docs or provide more information if requested.

4. Receive the Funds from Your Lender

There are typically are a number of ways to receive the money. The most familiar way is based on direct transfer from the lending company to your bank account. Some lenders in developing countries give just cash.

When you opt for more elaborate loans like car credit, the lender may send the funds to your car dealer. Similarly, this approach is used when you consolidate debt so one creditor sends money to another one, like when you refinance student loans.

Make sure you understand how you’ll receive the money before sending in your application.

5. Make Regular Payments on Your Personal Loan

Regardless of the way you received the money, there will be predefined term and monthly/weekly/daily repayments. Again, it’s important to understand all the terms before taking the loan. This is one area in life where it’s important to read the fine print.

Figure out how you will return funds, how much, and when. Remember that some companies list fees for late or even early repayments. And, of course, be sure to stick to the repayment schedule to avoid extra charges and credit score penalties.

Where to Find the Best Personal Loans in 2019

Within all the mentioned lending options (bank, government, a private firm, P2P network), large banks and governments can all be good options. Feel free to use online comparison tools to find the most suitable offers. We highly recommend Credible. Credible is an online marketplace that provides borrowers with competitive, personalized loan offers from multiple trusted lenders.

Compare offers from lenders with Credible.

 

Is It a Good Idea to Apply for a Personal Loan?

This is a tough question. It really depends on what you plan to use the money for. Remember that the loan always must be returned. You can’t just keep taking out personal loans and living off them forever. It’s not free money.

Personal loans are valuable if they’re used responsibly. If you really need money this month for an emergency, taking out a personal loan might be the best option for you.

If you really want to go back to school because you’re confident that having a degree will help you get a better job, then applying for a personal loan could be a great decision.

No matter what make sure the company is reliable and trusted, the loan meets your purposes, and you’re sure that will be able to repay the loan.

Grant Sabatier

Creator of Millennial Money and Author of Financial Freedom (Penguin Random House). Dubbed "The Millennial Millionaire" by CNBC, Grant went from $2.26 to over $1 million in 5 years, reaching financial independence at age 30. Grant has been featured in The New York Times, Wall Street Journal, BBC, NPR, Money Magazine and many others. He uses Personal Capital to manage his money in 10 minutes a month.

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Posted in: Loans, Personal Loans

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