How Do Personal Loans Work? A guide for first-time borrowers

Author: Better Path Financial | Categories: Credit Card Debt , Credit Counseling , Debt Consolidation , Debt Help , Debt Settlement , Financial Help , Financial Service Consultants , Home Equity Line Of Credit , Personal Finance , Underwater in Debt


Getting a loan is stressful even under the best circumstances. If you have good credit, you can likely qualify for a secured loan, meaning you can use your house or car for collateral. No matter how good your credit is, don’t settle for the first loan you apply for. Take the necessary time to source the best rates and terms.

When you have bad credit, the challenge increases exponentially. Without collateral, there’s more risk to the lender, so interest rates are higher and the borrowing limits are lower.

In either case, your interest rate and terms will largely be determined by your credit score. Do what you can to improve that before seeking out a loan. For help with fixing bad credit check out Save Source’s 4 Tips on How to Repair Bad Credit.


Tighter restrictions of personal loans

People with poor credit will face more fees and restrictions than people with good credit. For example, they will have less leeway about payback options. Personal loans must be paid back over a set period with a predetermined number of scheduled payments.

If you are in a situation where your only option is a personal loan, you need to do some research to ensure the loan doesn’t make your financial situation even worse than it already is. That means understanding the loan terms so that you know you are comparing apples to apples.


Monthly payments

The term 'monthly payments' is pretty self-explanatory. It is the amount you pay back every month. Your monthly payments will be determined by the amount you borrow, the interest rate, and the term of your loan. When determining your monthly payments, it’s important to ensure it’s an amount you can afford month to month.


Loan repayment period

The repayment period of the loan is the entire duration of the loan. In general, with personal loans, you will be required to make fixed monthly payments for a predetermined period. Obviously the longer the repayment period, the more interest you will have to pay and the more the loan is going to cost you.


Loan minimum and loan maximum

Different lenders will have different minimums they are willing to lend and different maximums. If a lender won’t lend you enough to cover your needs or requires you to borrow (and pay back) more than you are looking for, it’s probably not in your best interest to go with them.


Annual percentage rate (APR)

The annual percentage rate is a calculation of the total cost of the loan for each year that you carry it. That includes your payments, interest, and fees. A lower APR will cost you less over the duration of the loan. Your APR should be the most important consideration when choosing your lender. People with poor credit will likely face a higher APR, but with some research, they can still make the best choice possible.


Should you consider a personal loan?

With so many challenges inherent in personal loans are they still a good idea? In certain circumstances, a personal loan might still help you save money. For example, if you have a high-interest credit card, you might secure a personal loan to pay it off to save you more in the long run. Or you might use the loan to pay off multiple high-interest debts to bring your payments down to a single payment, again to save more over the long haul.

However, before taking on any type of loan it’s imperative to do the math. Consolidating all your debts into a single payment through a personal loan doesn’t make sense if the interest and terms are going to cost you more than what you would have paid otherwise. For example, the personal loan you’re considering might mean a lower total monthly payment than you are currently making. However, if you have to continue making that lower payment over a longer period, than you would have without the loan then it is of no benefit to you.