In the quest to find the best loan offers available, a potential borrower is bound to encounter different lenders, each with unique requirements. For some lenders, it is imperative to state your purpose of the loan, and there are often measures in place to ensure that the loan disbursed is used for the said purpose.
Other lenders are not so pragmatic in approach. Once the loan is disbursed, they put the utmost priority on repayment of loans only. For this second group, personal loans are a prominent service.
The idea of a personal loan is that it is to be used for personal expenses. It is not necessarily stipulated in your application, but a personal loan can serve a wide range of purposes, some streamlined by the lender, others left to the discretion of the borrower. Personal loans are offered by almost every finance company you walk into.
Unlike auto loans, boat loans and mortgage, another interesting perk of choosing personal loans is that they do not typically require collateral. Car loans come with the purchased car as collateral, and mortgage loans come with the home purchased as collateral, but personal loans do not require any of these. The borrower is likely to make up for this by paying higher interests than the aforementioned.
For collateral loans, a default in payment is tantamount to the forfeit of the collateral. Subsequently, the collateral asset is repossessed and sold off to repay the loan. For personal loans, delay and default in repayments will cost the borrower more accumulated interests that may lead to an unending cycle of debt if not managed well enough. Still, on interest rates in the context of personal loans, the costs may be influenced by the borrower’s credit score and debt-to-income ratio.
Your credit score simply refers to your creditworthiness, determined by your ability to repay loans on time. Typically a number between 300 and 850, your credit score is calculated by credit bureaus after a careful observation of your credit history with different financial institutions.
The debt-to-income ratio is calculated by dividing the monthly debt instalment amount by your gross monthly income. Lenders use this to gauge your financial capability to handle monthly repayments based on your requested loan amount, interest and additional fees included.
That established it is worthy of note that personal loans, although typically unsecured, can be secured loans as well. Collateral can be any valuable asset of the borrower, valued against the requested loan amount.
Whether secured or unsecured, failure to comply with the repayment timeline is not without penalties, especially to the borrower’s credit score and access to future loans from the same lender or a new lender. So far, all the salient points made beg an important question of:
When exactly should you consider taking a personal loan? The answers to these are:
- When you are in need of funds for a short period and within the means to repay on a stipulated date. Personal loans can be repaid between 12 and 16 months, affording you time to pay in bits. Bearing in mind that the longer you take to repay your loan, the higher up the interests go, you should endeavor to repay your loan as soon as possible.
- If you don’t have any asset to tender as collateral. Not everyone owns a fancy property, a car or a boat or valuable jewelry. If you fall in this category, or you are just not willing to put your valuables on the line for a loan, then personal loans are for you.
- When your financial need is beyond what credit card loans can handle. Credit card loans are limited in amounts and not suitable for certain financial situations, precisely the ones that require a lump sum of money. Personal loans have you covered instead.
- When you don’t qualify at all for a credit card loan; probably as a result of a low credit score. Everyone needs financial help, whether or not they have a good credit score. Some lenders are willing to do business with you even with your low credit score. Personal loans and timely payments of them can be a good way to boost your creditworthiness!
Practically, personal loans can be taken on the following scenarios and used for these purposes:
Purchase Of Property / Car / Machinery
Taking out a personal loan to suit these needs makes for a better financial decision than dumping it all on your credit card companies and repaying with huge interests in exchange. Whether to replace a home appliance or to make a brand new purchase, personal loans are a good bet. A good alternative to this is a Home Equity Loan / Home Equity Line of Credit (HELOC) with lesser interest rates, but not without collateral (your home)
Consolidating Credit Card Debt
Owing one or multiple credit card loans can be very risky to your financial stability as a result of accumulating interests. What better to get your multiple debts out of the way in a single stroke than with a personal loan? With the correct procedure, debt consolidation using a personal loan can be a shot at financial redemption and ultimately, an escape from a debt crisis.
The average credit card loan has an interest of about 19.24%, while that of the average personal loan is 9.14%. Multiple debts are stressful to keep track of and repay, and with the right amount, you can merge all those debts into one, and for a lesser rate. A good alternative to taking personal loans in this situation is transferring your balances to a new credit card with a lower interest rate. You stand a chance of getting a complimentary waiver for a couple of months.
Consolidating Other High-Interest Debts
Credit card loans are not the only types of loans with high-interest rates. Top of the list is payday loans, with interest rates as high as 40%! Old, unpaid loans can also become a big mess of surging sums of interest rates, plus origination and fees that are waiting to gobble up your entire income without an end to it in sight. Taking a big personal loan will save you from the financial hassles of keeping up with such high interest rates. To enjoy the benefits of this decision, go for personal loans with relatively low-interest rates.
Paying For An Upcoming Event
This is not considered a good financial decision, but people do it anyway. Events such as anniversary parties, wedding parties, and other parties to celebrate milestone sometimes require more than you can afford. To cater to your upcoming event, you can take out a personal loan and commit to repaying on monthly instalments. While this may be a viable, quick way out of financial constraint, you stand the risk of years of debt when the occasion is over. If you must take a loan for this purpose, ensure it is in small amounts payable in a short time. You may take out a small loan to complement what you have gathered. These recommendations also apply when considering taking personal loans for vacations.
Boosting Credit Score
If your credit score tanked because of bad debts in the past, you have limited access to loans from many lenders who consider credit score a core eligibility criterion. To improve your credit score, you can take out a new personal loan and make timely repayments. This step can also help your credit mix; which implies that you are capable of servicing multiple loams successfully; a credit score booster.
It is vital to mention at this juncture that in the quest to improve your credit score, you should not take personal loans impulsively. A low Credit Utilization Ratio is better than getting submerged in debt because of a trial-and-error experiment with your finances. Only take out loans when you need them, and when there are no other means of raising the money needed. For example, a loan from family and friend may not come with interests as would traditional loans. Explore such alternatives first.
In conclusion, personal loans can be a lifesaver, but be careful with them. Ensure that you consider other options that better work for your loan purpose and capability. Also, ensure that you use the disbursed loan for the purpose for which it was requested.
It is better to stay off debts altogether, but with the right calculations and research, personal loans can remain a convenience.
