5 Things to Know Before Applying for a Personal Loan
3 min. read
By: FCU Team
1) How Personal Loans WorkBefore you decide to take out a personal loan, also known as a signature loan, it’s essential you know what this kind of loan entails and its impacts. Personal loans are a form of installment credit. Unlike a revolving credit line, such as a credit card, loan recipients are given the agreed upon amount up front and they are expected to pay it back with interest over time. The money from the loan is usually deposited into the borrower’s checking account and they are expected to pay back the sum in regular, monthly installments.
A few elements of a loan you need to understand before you apply include:
- Annual Percentage Rate (APR): This is the total yearly cost of your loan including the interest rate and any additional lender fees.
- Interest Rate: This is the amount your lender charges you for borrowing money. Your interest rate will be a percentage of the amount borrowed.
- Unsecured Loan: Most personal loans are a form of unsecured debt, meaning there is no collateral required to take out the loan.
- Loan Terms: Your loan term is how long you have to repay your loan. The length of your loan term can also determine the interest rate your lender requires.
- Loan Origination Fees: Many lenders will charge a loan origination fee, which are deducted from the principal loan amount. This means if you apply for a $5,000 loan and your lender charges a 5% loan origination fee, you’ll receive $4,750 in your checking account.
- Loan Agreement: This is the legal contract between you and the lender, which includes the total repayment amount, the APR, late charge amounts, payment schedule, how to repay your loan, and the consequences of defaulting on your loan.
2) What Are Personal Loans Are Used For?There are various reasons someone may take out a personal loan, such as:
- Debt Consolidation: You may be able to save money on previous, higher-interest loans if you take out a new, lower-interest loan to pay them back all at once. This way, you only have one interest fee to pay back.
- Home Renovations: Many borrowers apply for a personal loan when making home improvements or any necessary repairs.
- Moving Expenses: The price of moving can add up quickly, and borrowers will take out personal loans to cover the costs of moving to a new home.
- Unexpected Expenses: Whether it’s medical bills or unforeseen emergencies, a personal loan can help borrowers cover every curve ball life throws.
3) When Personal Loans Shouldn’t Be UsedWhile personal loans can be used to cover a wide range of expenses, there are a few bills that shouldn’t be paid for with this type of loan. For the following expenses, there are either other more suitable loan types that should be used or it is not recommended that loans be used to cover these expenses at all — this includes:
- Paying College Tuition
- Starting a Business
- Making a Down Payment on a Home
- Paying for Basic Living Expenses
4) If A Personal Loan Is Right for YouYou’ve heard the saying “Just because you can, doesn’t mean you should.” This is never truer than with your finances. You may qualify for a higher personal loan, but taking it out may not be the best strategy for your budget. If you have a low credit score, you may get a higher interest fee that is out of your budget. You should also consider that taking out a personal loan adds to your debt, so if you are approved for a higher loan amount than you feel confident you can pay off, you should take a step back to reconsider your options.
5) What Lenders ConsiderEach lender may have a different approach to approving potential borrowers, but most are looking for a few crucial elements when they are issuing loans. The most common metric you’ll be measured based on is your credit score which is composed of:
- Payment History (35%),
- Amounts Owed (30%),
- Length of Credit History (15%),
- New Credit (10%)
- Credit Mix (10%)
Lenders are trying to confirm that you are a safe bet, meaning you can be trusted to pay back the entirety of the loan plus interest. To this point, they will also check to see if you have a steady monthly income and a low debt-to-income ratio.