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    Home » What Is a Personal Loan?
    How Does a Personal Loan Work?
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    FinTopiAuthorBy FinTopiAuthorAugust 2, 2022Updated:June 14, 2023No Comments6 Mins Read

    What Is a Personal Loan?

    There are a lot of different types of loans you can apply for, one of them being a personal loan. 

    Usually, a personal loan is taken out for multiple reasons,  such as medical bills, home renovation, or any other form of expense. It’s very important to know that these loans are not secured, meaning they are not backed up by collateral, like a home or car. With that said, this loan has a higher interest rate in comparison to secured loans, such as mortgages. That’s why it is very good to have a plan and to be well informed before you go for it.

    When it comes to this type, a borrower usually takes a personal loan from a bank, which is then paid back in a specified period of time. This loan can be taken for numerous reasons, such as buying a new house or any other expense. Before you decide to apply for a loan, it’s very important to understand how it works. Here we will explain some basics of a personal loan.

    Table of Contents

    • How Does a Personal Loan Work?
    • How Do You Qualify for Personal Loans?
    • Types of Personal Loans
    • How Are Personal Loan Interest Rates Calculated?
    • What Can a Personal Loan Be Used For?
    • Final Thoughts

    How Does a Personal Loan Work?

    As previously discussed, a lot of people take this loan to pay out big expenses, like home improvements or even buying a new car. Because personal loans are not secured by collateral, it’s crucial to be able to pay them out in time. In case you are unable to do it, the lender can’t take your house or car as a backup, so it puts you in minus, and it can hit your credit score hard.

    Note that you most likely won’t get a personal loan if you have a bad credit score.

    Personal loans are usually used to secure your debt or pay off the high interest on your credit card. If you are thinking of getting this loan, it’s essential to understand how they work and what risks they bring. In this article, we will discuss important matters you need to know regarding personal loans.

    How Do You Qualify for Personal Loans?

    Before you even consider taking out this loan type, you should know that qualifications are required from the lender’s side. For you to even be eligible for this, you need to have a very strong credit score and a steady flow of income. Because they don’t have collateral, the lender needs to make sure you can pay it back. On top of that, a lot of lenders will request that you have a minimum amount of debt in order to get this loan.

    Types of Personal Loans

    Personal loans offer a couple of different options to borrowers. Based on this, you can decide which one suits you the best.

    Here are some of the most popular types of personal loans:

    1. Secured Personal Loans: This type is secured by collateral. If you fail to repay the loan, the lender can seize your collateral to cover up the losses. Usually, you will use your home, car, or investments for this loan.
    2. Unsecured Personal Loans: With this type, you are not giving the collateral, which is why the name is unsecured. If you halt the loan, the lender doesn’t have any way of covering their loss. That’s why this loan is usually more expensive than others since it is very risky for lenders.
    3. Peer-to-Peer Loans: Peer-to-peer lending is a recent form of borrowing money since you are not taking it from a bank or other financial institutions but directly from other individuals or investors. It commonly involves lower interest rates, but higher risks.
    4. Payday Loans: These are small, short-term loans that are commonly used to tide the borrower until the next payday.

    Some of these loans can be requested online. It’s a great way to save time and check if you’re eligible. Check with your lender if online personal loan is a possibility and if yes, go ahead and check the terms.

    How Are Personal Loan Interest Rates Calculated?

    There are numerous factors affecting the interest rate of personal loan, including:

    •  your credit score, 
    • income, and 
    • the amount you are looking to borrow.

    Based on this and the type of loan you choose, your interest rate will vary.

    It’s important to know that there are two types you can choose from, fixed-rate and variable-rate. Fixed-rate personal loans offer you a steady interest rate that stays the same during the life of the loan. The interest can change over time if you decide to go for the variable-rate personal loan.

    It’s good to research multiple different lenders, so you can get the best interest rate. Also, it’s very crucial to understand how the interest rates are calculated for this type of loan, so you can make the best decision for your needs.

    What Can a Personal Loan Be Used For?

    When it comes to a personal loan, there are multiple things you can use it for. Some people may use it for medical bills, while some use it for the unexpected expense they have. Also, there are people who use it to pay off high interest rates on their credit cards. At the end of the day, there is no fixed thing on what you can use this type of loan, and it can even be funding of your wedding or new house.

    No matter what you decide to use the loan for, just make sure you compare interest rates from different lenders and think well if you are able to pay it back later. Personal loans can be an amazing way to get the money you need, but you will not want to end up in bigger debt than you can handle.

    Final Thoughts

    When it comes to personal loans, there is not a set thing you can use the money for. That’s why this makes them a great thing for everyone. Even with that said, it’s a must to compare different lenders to find the best interest rate that suits you the most. 

    A great way to do that is to use a personal loan calculator and see what interest rate can work for you and your means. 

    In other words, even before you decide to take a loan out, it’s crucial to do your research and to make sure you can pay out the loan until the end. Just because it suits someone else, that doesn’t mean it will be a good thing for you and your financial situation.

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    FinTopiAuthor
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    The FinTopiAuthor, who prefers to remain anonymous for now due to privacy reasons, has a bachelor’s degree in finance and over 10 years of experience in financial planning and bank loans. For the last 3 years, they’ve been working as a freelance copywriter in the niche of financial products, investing, and money lending, with the special attention to pros and cons of different loan types. Besides an interest in financial topics, they’re keen on traveling and various adventures.

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    Table of Contents

    Table of Contents

    • How Does a Personal Loan Work?
    • How Do You Qualify for Personal Loans?
    • Types of Personal Loans
    • How Are Personal Loan Interest Rates Calculated?
    • What Can a Personal Loan Be Used For?
    • Final Thoughts

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