How Personal Loans Work
Credit comes in many forms, including credit cards, mortgages, automobile loans, purchase financing over time and personal loans. Each type of credit serves a certain purpose for a goal you may have, whether it’s to buy a house or car, or to allow you to break up a big expense into more manageable monthly payments.
A personal loan is a form of credit that can help you make a big purchase or consolidate high-interest debts. Credit can be a powerful financial tool, but taking out any type of loan is a serious responsibility. Before you decide to apply lendforall personal loans, it’s important to carefully consider the advantages and disadvantages that can affect your unique credit picture.
What is a Personal Loan?
When you apply for a personal loan, you ask to borrow a specific amount of money from a lending institution like a bank or credit union. You may seek a personal loan to help pay education or medical expenses, to purchase a major household item such as a new furnace or appliance, or to consolidate debt. Repaying a personal loan is different from repaying credit card debt.
Before you apply for a personal loan, you should know some common loan terms, including:
- Principal — This is the amount you borrow. For example, if you apply for a personal loan of $10,000, that amount is the principal. When the lender calculates the interest they’ll charge you, they base their calculation on the principal you owe. As you continue to repay a personal loan, the principal amount decreases.
- Interest — When you take out a personal loan, you agree to repay your debt with interest, which is essentially the lender’s “charge” for allowing you to use their money, and repay it over time. You’ll pay a monthly interest charge in addition to the portion of your payment that goes toward reducing the principal.
- APR — APR stands for “annual percentage rate.” When you take out any kind of loan, in addition to the interest, the lender will typically charge fees for making the loan. APR incorporates both your interest rate and any lender fees to give you a better picture of the actual cost of your loan. Comparing APRs is a good way to compare the affordability and value of different personal loans.
- Term — The number of months you have to repay the loan is called the term. When a lender approves your personal loan application, they’ll inform you of the interest rate and term they’re offering.
- Monthly payment — Every month during the term, you’ll owe a monthly payment to the lender. This payment will include money toward paying down the principal of the amount you owe, as well as a portion of the total interest you’ll owe over the life of the loan.
- Unsecured loan — Personal loans are often unsecured loans, meaning you don’t have to put up collateral for them. With a home or auto loan, the real property you’re buying serves as collateral to the lender. However, some lenders offer secured personal loans, which will require collateral, and could provide better rates than an unsecured loan.
How to Apply for a Personal Loan
Whenever you ask a lender for any kind of credit, you’ll have to go through the application process. However, before you submit a personal loan application, it’s important to review your credit report and your credit score, so you’ll understand what lenders might see when they pull your credit report and scores. Remember, checking your own credit report never affects your credit scores, so you can check as often as you need. Once you’ve reviewed your credit and taken any necessary steps based on what you see, you can apply for a personal loan through any financial institution such as a bank, credit union or online lender. Every lender you apply to will check your credit report and scores.