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What You Need to Know About Personal Loans

A personal loan is a form of credit that can help you make a big purchase or consolidate debt.
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Whether you want to consolidate debt or finance a wedding, a personal loan can help you borrow the money to achieve your goals.

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With a personal loan, you get a set amount of money and repay it in monthly payments, called installments, for a predetermined time. Depending on your loan, your loan term could range from one year to seven years with varying repayment terms.

After you’ve paid the balance down, the loan is considered paid in full. So, to borrow more money, you would need to apply for another loan.

How do personal loans work?

A personal loan is a way to borrow a specific amount of money. A mortgage can be used to pay for a house, and an auto loan can pay for a vehicle. But with a personal loan you can finance almost anything. For example, a personal loan could help pay for higher education, medical expenses, purchase major household items like furnace or appliances, or consolidate expensive debt.

Unlike credit cards, a personal loan provides a lump sum of money that you pay back every month until your balance reaches zero, while credit cards provide you with a line of credit and a revolving balance based on your spending.

Personal loans typically have lower interest rates than credit cards. So, consider using a personal loan to consolidate multiple high-rate credit cards into a one easy payment.

Repaying a personal loan is different from repaying credit card debt. With a personal loan, you pay a monthly fixed amount over a set period until the remaining balance is zero.

What to know before you apply

Before you apply for a personal loan, you should think about why you want it and evaluate other options. If you’re thinking about using a loan for something you want but don’t need, it’s probably better to save up for it instead of borrowing and paying interest. If that’s not an option, make sure you can afford to add the monthly payments to your budget.

Before you apply for a personal loan, you should know some standard loan terms, including:

Annual percentage rate (APR)

APR is the amount of interest and other costs (such as fees) that you pay to borrow money, expressed as an annual rate. The APR represents the total annual cost of borrowing money.

Interest

Interest is what you pay to borrow a sum of money, not including fees or additional charges. The interest rate is expressed as a percentage of the amount of money you borrowed. Interest rates are usually annualized.

Principal

The principal is the amount of money you borrowed from your lender, excluding interest. As you pay off your loan, this amount will decrease.

Term

Your repayment term is the maximum amount of time you have to repay the loan in full.

Monthly payment

Your monthly payment is the amount that you’re required to pay to the lender by a specific date each month until your loan has been repaid in full.

Origination fee

An origination fee is a fee that some lenders charge for initiating your loan application and issuing your loan. An origination fee is usually calculated as a percentage of your loan amount.

Prepayment penalty

A prepayment penalty is a fee that some lenders charge if you pay off all or part of your loan early. The penalty compensates the lender for interest you didn’t pay because you made fewer payments than the lender expected to receive.

Fixed interest rate

A fixed interest rate doesn’t change or adjust with an index during part of the term or the entire term of the loan.

Variable interest rate

A variable interest rate is a rate that can change during the loan term. Your loan agreement should specify how this rate is determined and under what circumstances it can change. A variable interest rate usually changes with the prime rate, as published in the Wall Street Journal.

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Bottom line

Personal loans can be a smart financial tool when managed correctly. But it’s essential to understand what you agree to. And it would help if you had a solid plan for repaying the loan.

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