Understanding how a personal loan works are essential for borrowers who want to take advantage of this option. These loans involve a lump sum that you pay back in fixed monthly installment payments, over a period of years.
Although many use these loans for emergency purposes when they prefer not to use their savings or have no savings, the funds are also ideal for purposes like debt consolidation. Read on to learn more about personal loans, how they work, and how one might help you.
What Is a Personal Loan and How Does It Work?
Personal loans are often known as unsecured, which means that they aren’t issued against collateral like your car or house. Your credit history and score, cash flow, and debt-to-income ratio are the criteria that lenders use when deciding whether to give you a loan.
When you get approved for a loan, you’ll receive your funds to use for whatever you borrowed the money for. Your loan will include terms for the monthly amount and how long you have to pay it back. These loan products work best when you make sure that you take out an amount you’ll be able to repay easily.
Knowing How a Personal Loan Works Helps You Make Better Choices
Prospective borrowers who understand the borrowing process works will be able to make better decisions. For example, personal loans often have higher interest rates than some lending products, but offer greater flexibility.
The Annual Percentage Yield, or APR, includes the fees paid on the loan, as well as the interest, so this is an important rate to pay attention to. Another important factor to look at is the repayment period, which may vary based on the amount you borrow.
How Will it Affect Your Credit Score?
Part of understanding how a personal loan works are knowing how the loan affects your credit score. There are four instances that have an effect on your credit score:
- Pre-approval – Being preapproved involves a “soft pull” with no effect on your score, however, you must formally apply.
- Applying – Applying for a loan, whether you’re approved or not, reduces your credit score by 5 points or less, and note of this stays on your report for two years
- Paying late – Making a late payment will affect your score each time it happens
- Making payments on time – Paying at least the minimum on-time helps your score, and paying more than the minimum helps further
Are There Limits to Using a Personal Loan?
One of the things that people enjoy the most about personal loans is flexibility. You may use your funds for virtually any purpose. Here are some of the most common usages:
- Consolidating multiple small debts – If you have several smaller debts, a loan can be an excellent way to get them out of the way once and for all. Focusing on repaying a single payment is more practical for a lot of people.
- Home Improvement – Loans can help finance home improvement projects. The added value to your home is worth it in the long run.
- Refinancing other loans – If you have other, smaller loans or debts, personal loans are great for getting these paid off. At the least, you can deal with a single payment, instead of multiple payments.
- Paying for vacations or weddings – Both these events can be very expensive. However, a loan may make it easier to pay for.
There are many things to consider when taking out a loan product, and CashLink is ready to help. Contact us with questions about how a personal loan works or any other concerns that you may have about the process.