There’s a strong probability that at some point in your life you’ll need to borrow money. You’ll try your parents, family and friends but their pockets might be just as empty as yours.
So, you’ll have to journey into the land of the federal government, banks, credit unions, and finance companies.
But first, the question must be answered.
What is a Personal Loan?
A personal loan is a debt taken on by individual consumers. Any debt. It includes mortgages, car loans, credit cards, payday loans and any other debt you personally take on. The personal loan system allows us to have what we want when it’s not totally paid for. It’s why banks and other financial institutions exist.
At the heart of the personal loan transaction lies a promise. A promise that you, as the debtor, will repay the money you borrowed to your creditor.
Personal Loan Types- Secured
Loan instruments exist for anything you want. They could be secured or unsecured. That’s what differentiates them. Let’s talk about secured first.
- Home Loans- This loan is secured against your home. This means if the covenant to pay is breached, the home reverts back to the mortgage holder.
Home equity loans use a percent of the built up equity (the difference between what you owe and what the home is worth) to secure the loan. However, you can use this money for many different purposes. You might be financing college, making home improvements or consolidating your debt.
- Vehicle or Boat Loan- Whether you have a lease or a loan, the car or boat acts as the collateral for it. If you fail to pay, the car or boat will be repossessed.
- 401K Loans- If you’ve accumulated enough money in your 401K, you can take a loan out against it. It’s secured because if you don’t pay it back the remaining 401K funds will cover it. This is how it works:
Let’s say you have 10K in your 401K. After a certain amount of time, you can borrow half of it. The remaining half covers it and when you pay the loan back, you’re really paying back yourself.
Personal Loan Types- Unsecured
Unsecured loans are just that. You, as the debtor, borrow money. The creditor takes it on faith that you’ll pay it back. If you don’t, other than extreme harassment and ruining your credit score so you can’t borrow any more, there’s nothing that can be done.
Here are some examples of unsecured personal loans.
- Credit Cards- The most common form of unsecured debt is credit card debt. These statistics from the Federal Reserve posted on the credit information site credit.com (http://www.credit.com) suggest unsecured personal loans continue to grow:
– From 1997 to 2007 American credit card balances increased 75%
– At the end of 2007, there was 972 billion in outstanding revolving debt in the United States
– The median balance for those carrying a balance is about $2200
- Signature loans- Simply state the reason you want the money and you can sometimes get a signature loan. This means you get the money with minimal documentation and little or no collateral. Basically, it’s loaned to you on your signature, credit score and ability to repay
- Pay day advance Loans- These are firms who will lend you small amounts of money to be paid back when you receive your pay check. The loans are intended to cover your expenses until then.
- Education Loans- Student and parent loans can be obtained to help finance the college expenses of your student. They’re called Stafford Loans, Parent Plus Loans and Grad Plus Loans. These federally guaranteed loans are made available through banks, credit unions and other financial institutions.
Interest rates vary greatly from loan to loan but in general, unsecured loans carry higher interest rates and greater penalties for late payments. In fact, often, secured home equity loans are taken out to pay off higher interest personal or credit card loans. That way the debtor payments decrease and they can deduct the home equity loan from their personal income taxes.
There are two major ways personal loans get repaid:
- Secured Loans- When you sell your possessions the proceeds go to pay the principle balance. That loan is then marked paid in full in one lump sum. If it doesn’t sell, you keep paying the installments
- Unsecured Loans- You pay in equal or unequal installments until the debt is paid off.
It’s all about cash flow. You may not be able to afford that furniture, vacation, home or car if you had to pay in full at the time of consumption. However, if you could pay the money back in installments it might be a doable proposition. That’s how the majority of personal loans get paid back. In equal installments over time.
Interest is the price you pay for that convenience.
Five Things to Consider When Getting a Personal Loan
- Risk- You must decide if you want to risk any collateral when borrowing
- Terms and Rates- With the smorgasbord of choices out there, shop around for the most advantageous rates and terms. Take advantage of the competition for your business.
- Ease of Doing Business- Decide when you need the money. If you need it quickly, it may be easier to go the unsecured route
- Lender- Research the lender on the internet. Talk to customers. Find out how the company operates. Again, take advantage of the competition for your business.
- Payback Ability- Make sure you have the ability to make your payments in full and on time. If you don’t your credit could be damaged making it impossible to get funds or you have to pay very high interest rates to borrow.
More information on Personal Loans
In addition to Credit.com mentioned above, here are two other government sources for information on personal loans.
To begin the process for student loans, check out the Free Application For Student Aid (FAFSA) at http://www.fafsa.ed.gov/
For information on home loans from the federal government go to http://www.usa.gov/shopping/realestate/mortgages/mortgages.shtml