Applying for a personal loan is a financial decision that the majority of people make in their lifetime. Due to the fact that this is a common thing, a lot of people approach the topic far more casually than would be considered smart. You see, a personal loan is a serious matter and if you’re not careful, you could end up paying more than you should for a lot longer than you should. Fortunately, with a bit deeper understanding of the topic at hand and some research on your part, you can ensure that you get a far more favorable deal. With that in mind and without further ado, here are several things that you should definitely know before applying for a personal loan.
1. Secured vs. unsecured loans
The first thing you need to understand when applying for a personal loan is the fact that there are two major types – the secured and the unsecured. The secured loan is the one that requires a borrower to submit collateral, so that the lender has a way of reimbursing themselves if the borrower is unable to return the money, on a later date. Due to the fact that these loans offer far greater security to the lender, they are often willing to go for more generous terms than they otherwise would.
Now, while discussing the topic of secured loans, it is crucial that we mention the topic of collateral. Generally speaking, collateral is an item of value that is accepted as security for a loan. So, in theory, it could be any valuable asset that you owe. Most commonly used are personal assets like an investment account, savings or a real estate that you owe. Most frequently used collateral loans are the home equity loans, however, there is also such a thing as collateral in finance. This can most often be encountered when it comes to the concept of margin trading.
The second type of personal loans are the so-called unsecured loans. Here, instead of a physical asset as a guarantee, one uses a metric known as a credit score to determine whether the potential borrower is financially trustworthy. Still, even the most reliable of algorithms isn’t as reliable as an actual asset, which is why the lenders are more at risk with unsecured loans. For this reason, they often come with a tad higher interest rate. In this way, the lender is trying to compensate for the risk that they’re exposed to with potentially higher gains.
2. Benefits of a personal loan
There are many benefits to applying for a personal loan. First of all, you can do this in order to pay for things with a low interest rate. You see, the majority of retailers incentivize immediate payments in order to encourage this kind of financial behavior. This means that by applying for a loan, you get to pay less interest than if you were to just to buy it with your credit card. Other than this, you also have the privilege of refinancing high interest rate with low interest rate, which can provide you with a significant boost to your current financial status.
Another thing you can do with a personal loan is to consolidate your debt. Let’s say that you have 3 or 4 debts that together amount to $5,000.00. By raising a single loan in this amount and using the money to pay off these debts, what you’re actually doing is consolidating. This means that the amount of money that you get to return remains the same but instead of four different loans, you now have just one to worry about. Now, the types of loans are one of the factors that determine your credit score (which is something that we’ll return to, later on). Other than this, instead of four separate payments, you get to focus on a single one.
The most important thing, however, lies in the fact that applying for a personal loan (unsecured one) allows you to borrow money without risking your assets. This alone is the reason why so many potential entrepreneurs use this method of financing instead of a business loan. In fact, the majority of startups are funded from personal means (personal loan is being one of them), while the second-biggest source of financing is loans from friends and family. The latter is also an inconvenience that you can avoid through a personal loan.
Of course, there are some downsides to getting a loan. The first major one is the likelihood of getting trapped in a debt cycle. This happens if you apply for more debt than you can afford, more debt than you could possibly repay. In that scenario, you would have to apply for a new loan in order to pay off the old one (which you were unable to pay off, to begin with). As you can see, this is a slippery slope that you’ll quickly find yourself on, unless you’re careful.
Another thing you need to keep in mind is the fact that personal loans often have somewhat higher interest rates. This is especially true for unsecured personal loans. Why? Well, because the less of a risk that you’re taking the bigger the risk that the lender has to take. So, due to the fact that they have to risk quite a bit, they’re trying to compensate for this by trying to make more money, which results in a higher interest rate. One more risk worth mentioning is the fact that you can get penalized for missing a payment or being late for a payment.
Finally, in this day and age, there are so many fraudulent parties online and the migration of lenders into a digital environment has made it particularly easy for them to pray on the unsuspecting parties. This is why one of the most important steps of precaution for anyone serious about getting an online loan is to check the reputation of the lender. Look for reviews and forum threads. In fact, going for a digital marketing-based approach and check their domain authority might also reveal a thing or two about their credibility.
4. Credit score
As we’ve already mentioned, unsecured loans require a credit score check. So, what is this credit score that we keep going on and on about? First of all, it’s a three-digit number that is there to determine your financial trustworthiness. The figure (of a FICO score) goes between 300 and 850. The bigger the number, the greater the score. As far as the scaling goes, a score between 300 and 579 is considered to be very poor, while the score between 800 and 850 is exceptional… you get the gist.
As far as the determining factors go, there are five major ones that you need to focus on (one of which we’ve already mentioned). Your payment history (how likely you were to miss a payment), the amount owed, the length of credit history, new credit and types of credit used are all taken into consideration. Still, this doesn’t mean that they’re all equally as important. For instance, the payment history is about 35 percent of your entire credit score, while the types of credit used are merely 10 percent.
Now that you know what your credit score is, you might want to take some steps to improve it (in order to get better loan terms). First, the above-discussed debt consolidation may be a step in the right direction. Second, you might want to start being more vigilant when it comes to your monthly payments (even your utilities and your mobile plan count). The thing to avoid is closing credit cards that you no longer use. Why? Well, because it shortens your credit history by quite the margin.