What Is a Personal Loan and How Does it Work?
If you're wondering "What is a personal loan and how does it work," you've come to the right place. With so many different loan options available, it can be tricky to determine what's best for your specific needs. The beauty of a personal loan is its versatility; it can be used to help cover a variety of expenses.
Here's how personal loans work and what they're most commonly used for.
The Basics of a Personal Loan
A personal loan is a short-term borrowing option that is typically repaid between one and seven years. Payments are set at the same amount each month until the loan is paid off. Most personal loans are also unsecured; therefore, no collateral is required. Interest rates are typically lower than those of credit cards.
As more banks and lenders have offered personal loan products, the market has grown extensively. Total personal loan balances are projected to reach an all-time high of $156.3 billion, according to TransUnion.
Rather than using credit cards to pay off large expenditures over time, a personal loan offers the advantages of lower rates and a set repayment schedule that fits into your monthly budget.
Personal Loan Uses
One of the most appealing aspects of a personal loan is that you can use the funds for almost any purpose. Some specific uses include:
- Debt Consolidation: By combining higher interest rate loans and credit card balances into one lump sum, you can streamline your monthly payments. Use a debt consolidation calculator to see the difference in payments and interest you could experience. A calculator can also illustrate how payments will change based on the time frame in which you plan to pay off your debt. The longer you take to pay back the loans, the lower the monthly payment — but keep in mind that you'll also pay more in overall interest.
- Improve Financial Wellness: A personal loan can help you free up money in your budget to add to savings. Using a personal loan to lower your monthly payments of existing loans through debt consolidation, use your credit cards less, and pay off future balances on time and in full can improve your credit score. Better saving and spending habits can help you achieve long-term financial goals, such as saving for a new home or securing a favorable mortgage.
- Large One-Time Expenses: Personal loans may also be used to fund large one-time expenses. You can apply for a loan to cover unexpected medical expenses, a once-in-a-lifetime trip, an investment opportunity, and even your wedding.
How to Apply for a Personal Loan
Like credit card debt, most personal loans are unsecured, meaning you don't have to put up collateral as a guarantee for repayment. You can apply for a personal loan either online or at a bank branch. If you're approved, funds may be transferred directly into your bank account. Repayment is easy, too — you can set up payments to be automatically deducted from your checking account each month.
If you're looking to borrow a lump sum to pay for an upcoming expense or if you need to pay off high credit card balances, you may want to consider a personal loan. If you still have questions regarding personal loans and how they work talk to a financial advisor.