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Financial Literacy

What Is a Personal Loan? Here’s Everything You Need to Know

As you explore different financial borrowing options, you may find yourself asking, “What is a personal loan?” For more than a decade now, personal loans nationwide have been growing in popularity, with Experian reporting 38.4 million personal loan accounts in late 2019. Once considered a last option for getting out of debt, today people are rethinking this misconception, and for good reason. 

What Are Personal Loans?

With the right interest rate and terms, a personal loan from a trusted lender can provide an avenue for getting out of debt, funding home improvements, refinancing existing loans and more. 

But before applying for a personal loan, it’s a smart idea to do your homework. Fortunately, Prosper has you covered. Today, we’ll be answering many of the common questions about personal loans, including:

What Is a Personal Loan?

A personal loan is money you borrow from a lender that you can use for almost anything you choose, like consolidating debt, renovating your home, paying for a wedding or taking a dream vacation. As with other forms of credit, the interest rate, payment terms, amount you’re eligible to borrow and lenders themselves can vary considerably, so it’s important to fully understand and weigh your options carefully.

Ways to Use a Personal Loan

There are many ways to use a personal loan, including for:  

  • Debt consolidation
  • Emergency expenses
  • Home repairs
  • Dream vacations
  • Wedding costs
  • Medical bills
  • Other large purchases

In addition to these specific purposes, a personal loan could be a lifeline during times of financial stress, like a recession, providing access to cash on hand to use as needed. 

Did You Know?

Using a personal loan to pay off credit card debt (26%) and fund large purchases (28%) are the two most common reasons people take out a personal loan, according to Experian.

Emergency personal loans may also be available for people who have lost their jobs to bridge the gap during a period of unemployment.

Regardless of how you plan to use a personal loan, consider the interest rate of the loan versus the debt you are assuming and the true cost, with interest.

Making Sense of the Different Types of Personal Loans

Understanding the various types of personal loans can be a little confusing, but it doesn’t have to be. Here, we break down the differences between:

Secured vs. Unsecured Loans

A personal loan requiring you to put up some kind of collateral, like your home or a car, is called a secured loan. Conversely, a loan without collateral is known as unsecured.

Collateral may be required if your credit history and/or current income do not meet a lender’s minimum requirements to borrow. In the event you default on a secured loan, the lender may seize your assets and sell them to reclaim the money you owe.

Collateral

The majority of personal loans, however, are unsecured and require no collateral to borrow. While you won’t be risking your home or car with an unsecured personal loan, defaulting still has financial consequences. Namely, defaulting can mean:

  • Damage to your credit score (which may impact your ability to borrow in the future)
  • A collection agency assuming your debt and wanting to be repaid

Therefore, it’s important to make sure you can afford your payments before applying for a loan.

Online vs. Traditional Loans

With a traditional loan, you’ll work with a lender in person, at a local bank or other brick-and-mortar location. As such, you’ll provide physical paperwork (such as financial statements and W2s) and sign documents in person. This is a great option if you’re looking for a face-to-face point of contact during the loan application process.

Online Loans

An online personal loan is like a traditional personal loan in that you borrow money and agree to pay it back under the terms the lender outlines. The difference is that you submit documentation, receive approval and sign any documents online. Not only are online loans convenient, they also tend to pay out quicker than traditional loans.

Additional Considerations: 

  • As with most things on the Internet, we recommend you use caution and work with only reputable lenders, such as Prosper.
  • Just as shopping in person may be more expensive than online, costs of operating physical bank locations may be passed on to you through loan fees and higher rates on a traditional personal loan. 

Fixed vs. Variable Interest Loans

Some personal loans have a fixed interest rate, meaning you’ll pay the same amount each month. Others offer variable interest rates that affect your monthly payment amounts. Typically, variable loans begin with lower interest than fixed rate loans. However, that rate could fluctuate depending on market conditions and changes to the Prime Rate.

The longer the loan term, the riskier a variable interest rate personal loan may become. A longer loan term means more time for the rate to rise, which could dramatically increase your monthly payments. A lender may charge a higher interest rate to borrow with a fixed interest personal loan. But with that comes the security of knowing your monthly payments will remain steady.

How to Determine Whether You Qualify for a Personal Loan 

Now that you have a clearer understanding of personal loan uses and the different personal loan types, you’re probably wondering whether you qualify. Here, we’ll be breaking down the four steps to determine your personal loan eligibility.

1. Check Your Credit Score

Your creditworthiness is the number one factor in determining:

  • Your eligibility for a personal loan 
  • How much you’ll be able to borrow
  • What kind of interest rate you’ll pay 

Get a free copy of your credit report to make sure the information is accurate before you apply for a personal loan.

2. Calculate How Much You Need to Borrow

Before applying for a personal loan, determine how much you need to borrow and for how long you want to make payments. It’s helpful to have a financial plan not only for taking out a loan but for the next few years while you pay it off.

3. Know Your Budget

You may want to borrow a certain amount, but if the payments on that size of a loan are more than you can afford, you likely won’t be approved. (Nor would it be a good idea financially.) Before you begin the loan process, make a budget. Doing so will help you determine the monthly payment you can comfortably afford.

4. Research Your Personal Loan Options

Not all lenders offer the same terms and conditions, customer service or convenience. Do your homework to find the best terms, rates and loans for your situation, and be sure to choose a reputable lender. Find out how Prosper can help you get the personal loan you need today.

What Is a Good Personal Loan Interest Rate?

If you’re considering using a personal loan to pay off credit card debt, the good news is that personal loans typically offer lower interest rates. That being said, they can still range from anywhere between 6% and 36%, with an average of 9.41% making it essential you weigh any option carefully.

Personal Loan FAQs

Q: How much can I borrow?

A: The amount you can borrow through a personal loan depends on the lender and your personal financial situation and history. Prosper offers personal loans from $2,000 to $40,000.

Q: How will I receive the money?

A: With an online personal loan through Prosper, the money will be directly deposited into your bank account after the lender receives your signed loan agreement. It may take longer to receive the funds from traditional loans, which may be issued as a check.

Q: Will checking loan interest rates impact my credit score?

A: Not with Prosper. However, this isn’t true of all lenders. Too many hard inquiries (when a creditor looks at your full credit picture) can impact your credit score, as these stay on credit reports for two years. Soft inquiries are checks for pre-approval purposes and do not land on your credit report. Ask lenders which type of inquiry they’ll make while shopping for interest rates.

To learn your current interest rate without affecting your credit score, simply enter the amount you’d like to borrow and answer a few other questions.

Q: How long can I take to pay back a personal loan?

A: The term length of a personal loan is typically between 12 and 60 months. With a personal loan through Prosper, you may choose between fixed 3- or 5-year terms.

Q: What if I don’t qualify?

A: Per the Equal Credit Opportunity Act, lenders must tell you why your loan was rejected or give instructions on how to learn the reason(s) for your denial. You then have 60 days to request the reason(s). From there, you can take steps to improve your credit score and pay down credit card debt to improve your debt-to-income ratio. You might also consider a secured loan (if you originally applied for an unsecured loan) before applying again.

16 Personal Loan Terms You Need to Know

If you find financial terminology intimidating, you’re not alone. To make applying for a loan a little less overwhelming, let’s look at some of the personal loan terms you’ll likely come across.

Annual Percentage Rate (APR)

APR is the total cost of borrowing. APR includes not only the annualized rate of interest charged by your lender, but also any other costs of the loan, including loan origination fees. APR is expressed as a percentage that represents the actual yearly cost of borrowing over the full term of your loan. 

Example

For example, a loan with a 12.5% APR will cost you $125 a year for every $1,000 borrowed and left unpaid annually. The lower the APR, the less your loan will cost you.

Credit Score

Your credit score is a measurement of your ability to pay back money you’ve previously borrowed from lenders and credit card companies. FICO® Scores are calculated using several pieces of data in your credit report.

This data is grouped into 5 categories:

  1. Payment history (35%)
  2. Amounts owed (30%)
  3. Length of credit history (15%)
  4. New credit (10%)
  5. Credit mix (10%)

The Result

The result is a 3-digit number, from 300 to 850, that provides potential lenders insight into your level of risk as a borrower. While FICO® officially considers a score of 670 or above to be Good, Prosper’s Prime Platform requires applicants to have a credit score of just 640 or higher to qualify. According to FICO®, two-thirds of Americans have a Good credit score.

Cosigner

A cosigner is another person on your personal loan application. They take on shared responsibility for the loan without having ownership of it. Cosigners lend their good credit (typically with a credit score of 720 or higher) as support for your loan.

Additionally, an ideal cosigner will also have:

  • A stable employment history
  • Been at their current place of employment for over a year
  • A long history of making payments on time

Your cosigner on a joint personal loan is only responsible for your monthly payments in the event you fail to repay the loan.

Default

A default is a failure to fulfill an obligation, such as to repay a loan. Defaulting occurs when you don’t make payments on time, miss payments or stop making payments on the interest or principal owed on your loan. Defaulting happens in stages, the first of which is delinquency. If you’re delinquent on a loan, it will be reported to credit agencies. Following delinquency, if you still don’t make your loan payments, you’ll be in default, which can negatively affect your credit history and credit score for up to 7 years. 

What happens?

What happens next depends on whether your loan is secured or unsecured. If your loan was secured with collateral, you may lose your home, car or the investments you put up as collateral. Furthermore, if the proceeds from the sale of your home, car or other collateral don’t cover your outstanding debt, you could still be responsible for the remaining balance. 

Unsecured personal loans don’t carry these kinds of default consequences, however defaulting will raise a red flag to future lenders. This means it will become more challenging to get a mortgage, credit cards and other forms of loans and credit.

Fixed Payments

Personal loan payment amounts that don’t fluctuate are called fixed payments. With a fixed payment loan, you’ll pay the same amount each month until your loan is fully paid off. 

Interest Rate

A personal loan’s interest rate is the financial cost of borrowing money. Expressed as a percentage, lenders apply the interest rate to the total unpaid amount of your loan. While making your monthly payments, a portion of each will be paid toward the principal balance of your loan, with the other portion going to the lender as a payment for lending you the money.

Fixed vs Variable

Interest rates on personal loans may be fixed (meaning it remains the same for the length of the loan) or variable (meaning it changes over time, usually tied to the Prime Rate). When applying for a personal loan, the interest rate offered to you will be based on a number of factors, including your creditworthiness and the risk of default you pose to the lender.

Lien

A lien is the lender’s legal right to an asset (a home or vehicle, for example) that will be used as collateral for a secured personal loan. In the case of a loan default, the lender you borrowed from may be able to seize the asset.

Net Income

Net income is the amount of money you make after any taxes and deductions (retirement plan savings, health and life insurance, etc.) have been removed from your gross pay. Also referred to as your take-home pay, net income is one factor lenders consider when determining how much money you qualify for and whether you are able to repay a loan.

Payoff

The payoff amount is the total you’ll need to pay to satisfy your loan’s terms. The payoff includes the remaining principal balance plus the accumulated monthly interest you’ll owe through the day you intend to pay off your loan early.

Prequalification

When a lender estimates the amount of money you can borrow based on self-reported credit information, it’s called a prequalification. Prequalifications are conditional, meaning the lender will still need to review your creditworthiness before actually approving your loan. 

Prime Rate

The Prime Rate is the rate of interest based on the federal funds rate that banks use to lend each other month, and is the interest rate commercial banks charge large corporations to borrow. The Prime Rate is typically the starting point for other interest rates.

Principal

The amount you borrow is called the principal. The principal balance decreases as you make monthly payments until your loan is paid off in full at the end of the term. 

Secured Loan

A secured personal loan is backed by financial assets you already own, such as property, a vehicle or financial investments. The lender will place a lien on this collateral, which gives the lender legal rights to the assets if you default on your loan. In the event of a default, the lender may repossess your collateral and sell it to recoup the money you borrowed.

Terms

The terms of the loan are the actual terms and conditions involved when borrowing money. These include the repayment period, your monthly payment amount, the loan’s interest rate and any fees (for example, origination fees, an early payoff fee, etc.). It’s critical that you review all the terms of a loan before borrowing any money. 

Unsecured Loan

An unsecured personal loan is one issued without the need for collateral. Instead of lending you money against the value of a house or a car, for example, unsecured personal loans are approved and issued based on your creditworthiness. 

Variable Payments

Repayment amounts that fluctuate are called variable payments. Payments on these types of loans vary because the interest rate is variable, which means it fluctuates with market conditions. This means you will pay different amounts each month until your loan is fully paid off. Often, a variable loan starts with a lower interest rate than a fixed-payment loan but can rise dramatically based on the Prime Rate and other market factors. 

Is a Personal Loan Right for You?

To find out whether you qualify, check out our easy-to-use personal loan calculator.

All personal loans made by WebBank, Member FDIC.

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