A beginner’s guide to personal loans

The world of personal loans can be confusing, especially if you’re a first-time borrower. But don’t worry—we’re here to help. This ultimate guide will cover everything you need to know about personal loans.  

What is a personal loan?  

A personal loan is a type of loan you can use for anything from starting a business to paying off other debts. Unlike auto or home loans, which must be used for specific purposes, personal loans can be used for anything. Some common uses for personal loans include debt consolidation, home improvement projects, and medical expenses. 

Once you have the loan, you’ll make monthly payments until the loan is paid off. The terms of your loan will determine how much you pay each month and how long it will take to pay off the loan. 

How do you get a personal loan? 

 You can get a personal loan from a variety of different sources, including: 

• Banks 
• Credit Unions 
• Peer to Peer Lenders 
• Online Lenders 
• Consumer Finance Companies 

You’ll be required to complete an application and provide basic information about yourself, including your employment history, income, and social security number. The lender will then use this information to help them decide whether or not to approve you for a loan and what interest rate to charge you. 

What happens when you apply for a personal loan?  

Your lender will check your credit report  

First, your lender will perform a hard credit check. This is where they’ll pull your credit report and score from the three major credit bureaus: Experian, Equifax, and TransUnion. They’ll use this information to determine whether or not you’re a good candidate for a loan. Additionally, the lender will look at your employment history and income to decide how much money they’re willing to lend you. 

Your lender will look at your debt-to-income ratio  

Your lender will also look at your debt-to-income (DTI) ratio. This measures how much you make in monthly payments compared to how much you make each month. A high DTI ratio means you have a lot of debt and may struggle to make monthly loan payments—a red flag to lenders. 

They may offer you a loan—conditions will apply 

After reviewing your credit report, employment history, and DTI ratio, the lender will decide whether or not to approve you for a loan. If they approve you, they’ll also determine what interest rate to charge you based on your creditworthiness. The better your credit, the lower your interest rate will be. 

You’ll get the loan if you accept the terms and conditions 

You’ll be given a set of loan terms and conditions to review if you’re approved for a loan. These terms will include the money you’re borrowing, the interest rate, and the time you must repay the loan. Once you’ve reviewed and accepted the terms, you’ll get the money from your loan. 

Your credit score will change

Getting a personal loan will result in a hard credit inquiry, temporarily lowering your credit score by a few points. However, your credit score will recover over time if you make your monthly payments on time and in full. 

What happens once you accept a loan?  

Money is disbursed into your account

Once you accept your loan, the money will be disbursed into your bank account. This usually happens within a few days, but it can sometimes take up to a week or longer. 

You’ll start making monthly payments immediately

Your first loan payment will typically be due one month from your loan disbursement date. You’ll then make monthly payments until your loan is paid off. Your loan terms will determine how much you pay each month and how long it will take to pay off the loan.  

Interest and fees begin to accumulate

You’ll also start accruing interest and fees on your loan immediately. The interest rate will be determined by your creditworthiness and the type of loan you’re taking out. Personal loans typically have lower interest rates than other loans, such as credit cards or payday loans. 

You’ll be accountable for paying it off over a set period

You’ll be responsible for making your monthly loan payments on time and in full until your loan is paid off. If you miss or make a late payment, your lender may charge additional fees. Additionally, missing payments or making late payments can damage your credit score. 

You may acquire extra fees and penalties

If you can’t make your monthly loan payments, your lender may charge additional fees. Additionally, your loan may go into default, which can damage your credit score and result in the collection of your debt. 

What happens if you can’t repay your personal loan?  

A few things could happen if you can’t repay your personal loan. 

Your lender may develop a new repayment plan

If you’re having trouble making your monthly loan payments, your lender may work with you to come up with a new repayment plan. This may involve extending the length of your loan or changing the terms in some other way. 

You may be charged additional fees

If you can’t make your monthly loan payments, your lender may charge additional fees. Additionally, your loan may go into default, which can damage your credit score and result in the collection of your debt. 

You could file for bankruptcy

If you cannot repay your debt, you may be able to discharge your debt through bankruptcy. However, this will damage your credit score and may make it difficult to get loans in the future. Therefore, bankruptcy should be an absolute last resort and never be taken lightly. Be sure to consult a financial advisor if you think you’re in this situation.

Personal loans vs. other kinds of loans  

Student Loans  

Personal loans and student loans are both types of unsecured loans. That means they’re not backed by collateral.  

Auto Loans 

Auto loans are secured by your car, meaning the lender can repossess your vehicle if you default. Personal loans are unsecured, meaning the lender can’t take your property if you default. The downside is that personal loans typically have higher interest rates than auto loans. 

Credit Cards 

Personal loans typically have fixed interest rates, while credit card interest rates are often variable and may come with perks (like airline miles or cash back!) Additionally, personal loans have fixed repayment terms, while credit cards do not. 

Mortgages  

Mortgages and personal loans are both types of loans that can be used to purchase a property. However, mortgages typically have longer repayment terms and lower interest rates than personal loans. Additionally, mortgages are secured by your home, while personal loans are not. Therefore, you’d be better off taking out a mortgage to buy a home than a personal loan.  

Home Equity Loans (HELs) 

HELs are a type of loan that is secured by your home. If you default on your loan, the lender could foreclose on your home. Like mortgages, home equity loans typically have longer repayment terms and lower interest rates than personal loans. 

Payday Loans 

Payday loans are a type of loan that is typically due on your next payday. They have high-interest rates and can be challenging to repay. Trust us when we say they should only be taken out as a last resort.  

Alternatives to personal loans 

Equity loans  

A HEL is a loan that is secured by your home. If you default on your loan, the lender could foreclose on your home. Home equity loans typically have longer repayment terms and lower interest rates than personal loans. 

0% APR credit card 

 If you have good credit, you may be able to qualify for a 0% APR credit card. This means you won’t have to pay any interest on your card. However, you will still need to make monthly payments. 

Balance transfer credit card  

Another alternative to personal loans is a balance transfer credit card. This type of credit card allows you to transfer your balance from one card to another. This can be helpful if you have high-interest debt that you want to pay off or if you’re considering a personal loan due to an unexpected expense.  

Questions to consider before taking out a personal loan  

How long will I have to pay it back?  

The first question you should consider before taking out a personal loan is how long you’ll have to pay it back. Personal loans typically have repayment terms of three to five years. However, some loans may have shorter or longer repayment terms, so be sure to read the fine print before you agree to anything.  

How much will I pay in interest?  

You should also know how much you’ll pay in interest throughout the repayment period. Personal loans typically have fixed interest rates, which means your interest rate won’t change over the life of your loan. However, some personal loans may have variable interest rates. 

Can I afford the monthly payment and fees?  

Before agreeing to a loan, consider whether or not you can afford the monthly payment and fees. Personal loans typically have high-interest rates and fees, making them difficult to repay—especially if you’re living paycheck to paycheck. Be sure to look carefully at your budget to determine if you can swing the payments.  

Do I have a good enough credit score to take out a loan?  

Non-predatory personal loans are typically available to people with a fair credit score or higher. However, if you have bad credit, you may not be able to qualify for a personal loan, or you may be slammed with high interest rates that defeat the purpose of taking them out in the first place.  

What other choices do I have?  

The fifth and final question you should ask yourself is what other choices you have besides taking out a loan. Personal loans are not the only way to get money when you need it fast. There are also home equity loans, balance transfer credit cards, and personal lines of credit. Consider all your options before taking out a personal loan. 

Avoiding personal loan scams 

Don’t take loans if you have poor credit

There are many scams out there that target people with poor credit. These scams typically involve taking out a loan that the lender knows they won’t be able to repay. If you have poor credit, you should avoid taking out loans. 

Never send a lender money before receiving your loan

Another common scam is when a lender asks you to send them money before they give you the loan. This is called an “advance fee loan,” and it’s illegal. You should never send a lender money before receiving your loan. 

Only work with licensed lenders

Many unlicensed lenders out there are not registered with the government. These lenders may not follow the same rules as licensed lenders. Therefore, you should only work with licensed lenders to avoid getting scammed. 

Research your lenders thoroughly

Before taking out a loan, you should research your lender thoroughly. You can do this by checking with the Better Business Bureau or reading online reviews. Also, ensure you understand your loan terms before signing any paperwork. 

The bottom line on personal loans

Now that you know everything there is to know about personal loans, you can make an informed decision about whether or not taking out a loan is the right choice for you.  

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