What Is A Personal Loan?

What's a Personal Loan?
At some point in life you'll likely have to borrow money to pay for college, buy a home or car, renovate your home, consolidate debt or refinance existing loans at a lower interest rate.

If your parents turn you down, you'll likely have to go to lenders such as the federal government, banks, brokerages, credit unions, credit card issuers, finance companies and peer-to-peer online loan services.

In the wake of 2008's mortgage and credit crisis, it's a bit tougher to borrow money at favorable rates-but it's do-able. The trick with any loan is to qualify for the lowest possible interest rate, since the rate will determine how much you'll have to pay each month.

A personal loan is often more attractive than charging huge sums on a credit card because most lenders will offer a lower interest rate. A personal loan also is more ideal than borrowing from your 401(k), since that type of loan must be paid back within a specific time period, or else you'll face income taxes and an early-withdrawal penalty.

The interest rates that lenders charge will depend largely on your credit score.

In general, the higher your score, the better. Some lenders offer favorable interest rates to borrowers with scores over 680 while others use 720 as a base. Find out more about how credit scores work. See how your score compares to others with our credit score stacker.

The interest rate you're given also will depend on the length of your loan and whether your loan rate is fixed or variable:

• Fixed-rate loan. This type of loan locks in the rate you've been offered over a set number of years. A fixed loan is ideal when interest rates are rising, since you'll be locking in a low rate and your monthly payments will remain the same.
• Variable-rate loan. The interest rate offered on a variable-rate loan tends to be lower than a fixed-rate loan of the same duration. But you're facing more risk, since the rate moves in sync with the prime lending rate. Great news when the rate goes down, not so great when it rises.

2. Should You Borrow?
The interest rate you're charged on any loan is a big deal because it will determine how much you'll have to pay back each month. The higher the interest rate, the higher your monthly bill. And yes, the seemingly fractional difference between rates actually matters.

For example, if you take out a 15-year, $50,000 loan, and the rate you're charged is 11%, your monthly payment will be $568. If your rate were 8% instead on that same loan, your monthly payment would be $478. That's a savings of $1,080 a year.

Which is why you should exercise caution with variable-rate loans. Most borrowers who default on these do so because they didn't understand the terms and misjudged how much they'd owe each month in different situations.

To attract borrowers to variable-rate loans, many lenders offer an "introductory rate." This rate typically is appealingly low, fixed and lasts for up to 12 months, at which point the rate jumps to a higher one that is variable, meaning it can go higher and lower.

The only way to determine if a variable-rate loan with an attractive introductory rate is a good deal is to figure out how much your monthly payments will be once the introductory period expires and how much of an interest rate increase you can tolerate if the prime lending rate rises.

Many people take out variable-rate loans when they plan to repay the loan or refinance it at a lower rate in a relatively short period of time. However, it's easy for borrowers to get in trouble when they can't pay off or refinance the debt. Then they wind up trapped with a loan they can't afford.

3. Choosing a Lender
Even if your credit score is favorable and you know what type of loan you want, you still have to shop around. Not all lenders offer the same interest rates or terms.

How to choose a lender once you know what type of loan makes sense:

• Compare rates. With your credit score in hand, compare the rates that similar lenders offer. But also check the rates offered by different types of lenders, such as your brokerage, a credit union (if you belong to one) and even your credit card issuers.
• Call your bank. If you already have taken out a mortgage or a loan, ask your current lender about its offerings. You may receive a more favorable rate from your current lender if you have a solid repayment history.
• Know the terms. Once you know the rate you'll be charged by different lenders, compare their terms. Some have requirements that others do not. For example, some may offer a more favorable introductory rate while others will allow you to make two or more late payments without charging a penalty.
• Check the penalties. Some lenders charge higher fees than others for missed payments or early repayment.
• Verify the service. From time to time, you may have questions about your loan. Confirm that the lender's customer service is easy to reach. Also, if you prefer that the lender automatically deduct payment each month directly from your account, ask if that service is available.
• Review the refinancing process. If national interest rates drop significantly after you borrow, you may want to refinance your loan to get that better rate. Or you may want to refinance a variable rate loan to one with a fixed rate or a different loan period (from 30 years to 15 years, for example). Ask about the lender's refinancing process. Some provide existing borrowers with a streamlined turnaround.
• 
  

4. Grilling Guide: Questions to Ask Lenders

What to ask lenders to be sure you're getting the best deal:

What loan types do you offer? 
Lenders typically offer a choice of loans with different time periods and payment structures. Always find out how terms change over the course of a loan. Lower rate loans from the same lender tend to come with higher risks.

Is the rate fixed or variable? 
Loans come in many flavors. For example, some loans have a fixed rate-meaning the interest rate won't change over the life of the loan. Others have a variable rate-meaning it will rise and fall depending on the prime lending rate, which is indirectly set by the Federal Reserve. Variable rate loans tend to have lower rates than fixed-rate loans initially, but they come with the risk of rising over time.

Are there fees? 
Some lenders charge fees and points-finance charges you pay upfront when you sign the loan papers. Others waive those fees.

Is there an introductory rate? 
Some lenders offer a low introductory fixed rate on variable loans to attract business. Before you sign on, know how the rate works. Most last only a short period. Also be sure you qualify for it. In some cases, the ultralow rate in ads is available only to borrowers with sterling financial records.

Are on-time payments reported? 
Some lenders only report your missed payments to credit bureaus. You want to be sure that the lender also reports your positive payment history so your credit score improves.

Is there a charge for early repayment?
Some lenders penalize you for making extra payments or paying off the loan early.

What happens if a payment is missed? 
Bills can get lost, vacations can extend days longer than expected, or you may not have the cash in your account to pay the bill. Some lenders allow you to pay late once or twice without a charge or reporting it to credit bureaus. Ask about late-payment terms and penalties.