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The insiders guide to personal loans

When faced with a need for emergency funds, many people look first to a credit card. However, with interest rates on credit cards being as high as 25 percent, personal loans may be a viable alternative. This method of borrowing funds works well for individuals with good credit scores; those people with less than good credit should compare interest rates between personal loans and other sources carefully.

Personal loans can be used for a variety of reasons including debt consolidation, home improvement, education, business needs, auto financing, weddings, medical expenses and vacations.

Educating oneself about personal loans prior to signing on the bottom line is essential. Personal loans can be expensive. Some loans can have interest rates that exceed 300 percent. Payday loans are such examples. With some research and effort to read the contracts, it is possible to obtain a personal loan with a reasonable interest rate and term.

Loans are marketed under a wide array of monikers. They can be revolving, installment, secured or unsecured. Sometimes, a lender will use a number of terms to describe a single loan such as an unsecured debt consolidation loan.

Below is a list of lending terminology used in the business of personal loans.

Loans fall into two basic categories: secured and unsecured. Generally, secured loans feature lower interest rates when compared to unsecured loans. However, the borrower must offer collateral in exchange for the loan. This can be a car, boat or house among other things. If the borrower defaults on the loan, the lender may sell the collateral to repay the loan.

Unsecured loans have no collateral to back up the repayment. Frequently, these are called signature loans. The lender loans the money with just a signature on the contract. While a secured loan will result in the ability to borrow a higher amount at a lower interest rate, some people prefer not to risk an asset to obtain a loan. Prior to applying for any type of loan, the borrower should determine which method to use.

An installment loan has a set repayment schedule. The consumer borrows a specific dollar amount and pays it back with equal payments for a predetermined amount of time. Typically, the payments are monthly. Sometimes, installment loans feature an introductory interest rate that is lower than the term rate. In that case, the payments will increase after the introductory period.

Some installment loans offer a choice of the length of the loan such as 36 months, 48 months or 60 months. However, while a longer loan will have lower monthly payments, overall the interest charges will be greater than with a shorter-term loan.

A credit card is an excellent example of a revolving loan. The balance can vary from month to month, and the monthly payment can change accordingly. The consumer can pay off the entire balance at once or can carry the balance forward. Some consumers have had difficulties with credit cards by paying only the minimum payment each month. By doing so, it can take many years to pay off the balance, and the total interest charges can be quite significant.

The term personal loan came about to differentiate them from business loans. Personal loans come with more consumer discretion regarding the use of the money. They can be used for one large expense or several smaller purchases.

Frequently, consumers look to debt consolidation loans as a way to roll several credit card or loan payments into one. However, while this is the most common use, lenders rarely require a list of loans or proof of any other loan payoff in order to borrow the money. On occasion, a lender will make the payments directly to the other lenders to pay off debts. In this case, then the borrower would be required to supply a list of accounts.

With loans drawn against a retirement account, the consumer borrows the money that has accumulated in a 403(b), 401(k) or pension plan. Consumers cannot borrow money from an individual retirement account (IRA). The borrower can use the money on anything, and the loan is repaid to the retirement account. In addition, there is no reason for a credit check.

Commercial banks offer a wide array of loans from business, construction, asset based financing and personal loans. At a smaller local bank, the personnel on site may execute the underwriting on site. However, with a large national bank, the loan application will be processed electronically. Typically, the decision is made from a central underwriting department. While this is quite impersonal, there may be some benefits such as free checking.

These short-term loans are an advance on an individual’s upcoming paycheck. While very convenient, especially for consumers without access to a bank account, payday loans can be extremely expensive. Interest rates can exceed 200 and 300 percent. However, these loans can be very easy to obtain, hence their popularity with consumers who have bad credit. Payday loans obtained online can be particularly risky. Many have been overseas scams.

Typically, these loans are for small amounts made directly between consumers looking to borrow and an individual with money to lend. Generally, the contracts are installment loans with a term of approximately one to three years.

Many consumers looking for a personal loan are not seeking a large amount of money. Frequently, personal loans are smaller amounts to help families with unexpected expenses until the next bonus or payday. With some research and education about personal loans, a potential borrower can be certain to obtain a viable loan with a reasonable interest rate and term.

Mike Smith is a freelance writer who has been contributing to the Active Finance team for a number of years. His wealth of experience within the financial sector makes him the ideal candidate to offer an insight into personal loans.

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