Personal Loans 101: Borrowing Basics
Here are the basics of personal loans, and how they can help you get ahead.
Personal loans offer a fixed interest rate, a fixed term and are distributed as a lump sum. Want to learn about different types of personal loans, and how personal loans work?
Need extra funds for your next big vacation, wedding or a big-ticket item? Want to consolidate your debt? Or, do you need extra money to cover an unexpected emergency?
Personal loans can provide the flexibility you need to cover planned and unplanned expenses without breaking your budget.
If you’re not familiar with personal loans and how they work, we can help. Check out these basics of borrowing money using a personal loan.
What is a Personal Loan?
A personal loan, a.k.a. a signature loan, is a type of installment loan. Installment loans are approved for a set amount and are expected to be paid back at regular intervals or installments. The loan is disbursed to you in one lump sum payment with installment payments typically due on the same day of each month.
Lenders may offer personal loans with either fixed or variable interest rates. You may qualify for the lowest rate if you have good credit. The repayment period (or loan term) is usually no less than 12 months and may extend to five years or more. The account is closed once the loan is paid in full. To obtain additional loan funds, you must reapply.
Different Types of Personal Loans
There are advantages and limitations to the two types of personal loans. Your specific financial needs may make one more advantageous than the other.
1) An unsecured personal loan, which we offer at UW Credit Union, does not require collateral. Loan approval is based on your credit history, household income, employment history or other lender specific requirements. Your ability to receive the lowest interest rates and loan amount will rely heavily on your credit score and financial situation. Unsecured personal loans can exceed that of your average credit card.
2) A secured personal loan is backed by collateral which can be seized by the lender if the borrower fails to repay the loan as agreed. The loan limit is based on the value of the collateral.
Is a Personal Loan the Same as a Reserve Line of Credit?
Similar to a personal loan, an approval decision for a reserve line of credit is based on your credit history and your financial situation. A line of credit provides access to funds up to an approved credit limit. With a reserve line of credit, you are borrowing against the available credit, as needed. In this way, your line of credit works similar to a credit card.
Monthly payments are only required when you have an outstanding balance, and you only pay interest on the borrowed amount. The account stays open, and you can continue borrowing as long as you repay the loan according to the loan agreement. Use the available money again without reapplying or seeking new credit approval. Borrowers can access the line of credit by transferring the amount into their checking or savings account. Even though the lender sets the credit line limit, you decide how to use the funds.
Personal Loans Versus Other Loan Types
Although all loans must be repaid, different loan types have different use requirements. The repayment terms and interest rates available from the lender may vary depending on the loan you choose. The advantage with personal loans and lines of credit is that you’re allowed to spend the money on whatever you wish. With other loans, certain restrictions apply.
Auto loans are secured by the vehicle. Funds received for the auto loan must be used to purchase the vehicle. An auto loan refinance however may provide you with excess funds along with more favorable interest rates, but the vehicle still serves as collateral.
Student loans must be used for education-related expenses. No collateral is required, but there may be severe consequences for using the funds for anything other than the costs of education, e.g., tuition, fees, books, etc.
Business loans (not offered at UW Credit Union) are available only for commercial entities and operational related expenses. They are not available to pay off personal credit card debt. A business loan may require collateral such as real estate, equipment or other business assets.
The lending agreement outlines the specific use and limitations of the loan, including whether funds must be used for a specific purpose. If borrowers violate those terms or conditions, the lender could take legal action against the borrower. So, it’s important for borrowers to have a complete understanding of the loan requirements and the risk to collateral.
Other Benefits of a Personal Loan or Reserve Line of Credit
There are additional ways a personal loan or reserve line of credit can be beneficial.
- Both contribute to your credit score
- You decide how the funds are used
- If your emergency fund is depleted, it can be a low-interest option to bridge the gap
- Interest rates are lower than payday loans and most credit cards
- Collateral isn’t required, even when using funds for home or auto-related expenses
Personal loans provide people with a way to access money for personal expenses. Favorable repayment terms and low-interest rates make them an attractive option when compared to payday loans and credit cards.
UW Credit Union has competitive personal loan and reserve line of credit options that can meet your needs. Let us help you achieve your short- and longer-term financial goals!