Understanding Personal Loans and How They Work

3 MIN. READ

Personal loans are a great way to finance large purchases or consolidate debt, but it's important to understand the types of loans available and what is needed to qualify. In this blog post, we'll explore the basics of personal loans and discuss the key points to consider before applying.

What is a Personal Loan?

Personal loans are unsecured or secured loans that you can use to consolidate debt, carry out home improvements, pay for medical expenses or make other large purchases. With an unsecured personal loan, you don't have to put up collateral to obtain it. With secured personal loans, you do. This collateral might be your savings or a car or some other asset you own.

Over the past decade, personal loans have become more accessible and flexible, with more streamlined application processes and competitive interest rates. This has made personal loans increasingly popular with consumers who want to consolidate debt or finance large purchases. In the last few years, the COVID-19 pandemic boosted demand for personal loans as many people experienced financial hardship and were able to borrow money to cover expenses.

Before applying for a personal loan, it's important to consider a few key factors. First, you should have a clear understanding of your financial situation, including your credit score, income and debt-to-income ratio. You should also compare rates and terms to find the best deal. Finally, make sure you understand the fees and repayment terms associated with the loan, including any prepayment penalties or late fees.

Reasons to Consider a Personal Loan

People take out personal loans for various reasons. Here are some examples:
 

• Home renovations: Upgrading appliances, adding a room or remodeling your kitchen are huge expenses. With a personal loan, you can pay for these improvements in installments. After all, coming up with $30,000 upfront to update your kitchen can be a big stretch for many families.
• Debt consolidation: People also take out personal loans to streamline their monthly bill payments. For example, on average, Americans have four credit cards. Managing monthly payments for several cards with different interest rates and due dates is difficult. A personal loan will let you combine what you owe into one bill. You might even get a lower interest rate.
• Emergency expenses: Unexpected emergencies often add financial worries to the emotional distress already being experienced by individuals or families. If you suddenly lose your job, your car breaks down or you get sick or injured, the added burden may be beyond your resources. Personal loans can help make these costs more manageable and less unsettling.
• Taxes: Individuals or families that can't immediately cover their tax bill can often arrange a payment plan with the IRS. However, these payment plans carry interest fees and late penalties. It could be less expensive to take out a personal loan to cover any tax debt instead of setting up an IRS payment plan.
• Special life events: Personal loans are often used to help pay for expected expenses like weddings or unexpected ones like major car repairs.

Personal Loan Types

Several types of personal loans are available. These include:
 

• Short-term loans: These loans can make as much as $3,000 available and are designed to be repaid in a short period.
• Medium-term loans: With these loans, you can borrow up to $10,000 for larger purchases or debt consolidation.
• Large loans: Large loans can be as much as $50,000 and can be used to finance major purchases or combine large amounts of debt.

Pros of Personal Loans

The advantages of personal loans include:
 

• Flexibility: You can use the funds for any personal reason.
• No collateral required: For unsecured loans, you don't need to put up any assets to obtain the loan.
• Fixed interest rates: Many personal loans offer fixed interest rates, which means your monthly payment stays the same throughout the loan term.
• Streamlined application process: Many lenders offer a simple and quick application process.

Cons of Personal Loans

The disadvantages of personal loans include:
 

• Higher interest rates: Unsecured personal loans typically have higher interest rates than secured loans such as mortgages or car loans.
• Fees: Some lenders charge fees for loan origination, loan prepayment or late payments.
• Default risk considerations: For unsecured personal loans, lenders may charge higher interest rates or deny your application if your credit history is poor.

You should also think about factors such as repayment terms, fees and customer service when you look at personal loan options. It's also a good idea to check your credit score and make sure it's in good shape before applying for a loan. Finally, you may want to consider getting preapproved for a loan, which can help you narrow down your options and save you time during the application process.

Personal Loans at Power Financial Credit Union

We're here to get you the financing you need at a rate you can afford. Check out our rates for personal loans and apply today.