What is a Personal Loan?

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Personal Loans



So what is a personal loan? It’s a flexible, straightforward, and relatively affordable way to borrow money. If you need a loan to pay for emergency expenses, auto repairs, weddings or consolidating debt, a personal loan may be a good fit for you.

How Do Personal Loans Work?

With a personal loan, you borrow a fixed amount of money and repay that over a predetermined period of time – typically between 2-7 years. If you’re approved for a personal loan, your lender will give you the money up front, and then you’ll pay it back over the agreed upon period of time.

Applying for a personal loan can be simple and done directly through an online application. If you’re approved, you’ll receive the funds with the terms and conditions that tell you when to make your monthly minimum payment, how much your payments will be, and how long you’ll have to pay back the loan.

How Rates are Determined

Now that you know what a personal loan is, you’ll need to know how personal loan rates are determined. Factors like your annual income, payment history, debt-to-income ratio, and credit score can affect the rates you receive on a personal loan. Loan factors, like the loan amount and the number of years you can pay back the loan, can also affect your rates.

When we’re talking about personal loan rates, we’re really talking about annual percentage rates, or APRs. APR is a yearly rate your lender uses to charge you for a loan. Factors that may affect your personal loan’s APR are your annual income, payment history and debt-to-income ratio.

  • Annual Income: This is how much money you make in a year before tax deductions. You can think of this as your salary, the sum of earnings from multiple jobs you might have, child support, government assistance, or however you earn money throughout the year. Your lender will look at your annual income to help them determine how much money you can afford to pay back over the course of the loan.
  • Payment History: This is collected as part of your credit report and provides information on how you’ve paid your credit accounts over the length of time you’ve had credit. Payment history includes made payments, late payments and missed payments on your accounts. That history helps lenders make an informed decision about how likely you are to make future payments on-time.
  • Debt-to-Income Ratio: Generally, this is a calculation of how much of your monthly payments are for debts you owe on all of your accounts - whether that's loans or credit cards - divided by how much you earn. Lenders use this ratio to help them measure your ability to manage all of your debt and make your payments on the loan you’re applying for. 

Your Credit Score Dictates the Cost to Borrow

In addition to the factors above, lenders will typically look at your credit score to determine the terms of your personal loan. A credit score is a three-digit number that sums up your credit profile and tells lenders about your creditworthiness, or how likely you are to repay your loans. It’s calculated using the information that’s found on your credit reports and stored at the credit reporting companies (also known as credit bureaus).

Credit scores are calculated based on the likelihood that you’ll repay your loan. Generally, a higher credit score means you’re more likely to repay your loan and a lower score means you may be a riskier choice. This is based on a calculation that takes into account your payment history, current accounts and how much debt you currently have.

Types of Personal Loans

  • Unsecured Personal Loans: This is the most common type of personal loan. Unsecured personal loans don’t require any collateral. Instead, your lender will determine your credit worthiness for the loan based on the credit and income factors we’ve discussed above.
  • Secured Personal Loans: This type of loan is backed by some kind of collateral, like money, stocks, vehicles or homes. If you default on the loan, your lender can collect the collateral. Since you are securing the loan with collateral, it’s generally easier to be approved. However, you must have the collateral to get the loan.
  • Credit-Builder Loans: This type of loan is designed for people who don’t have any credit or are rebuilding their credit. Instead of receiving the loan amount up front and paying your lender back over time, you make fixed payments first and then get access to the loan at the end of the term.
  • Joint Loans or Co-signed Loans: If you aren’t able to get approved for a personal loan on your own, you may be able to get a co-signed loan. This is where someone you know – ideally someone with a strong credit profile - agrees to co-sign the loan with you. However, if you don’t pay back the loan, the co-signer will be responsible to pay it back.

What is a Personal Loan Used For?

  • Debt Consolidation: If you have several different credit accounts that you owe a lot of money on, you may want to consolidate that into one loan. This can be a nice way to help you simplify your life by making one monthly payment instead of trying to juggle all your loan payments.

  • Expensive Events: You may have an upcoming event – like a wedding or trip – that you aren’t able to pay for all at once. As a result, you might choose to use a personal loan to pay for that event up front and then you can pay it off over time.

  • Investing in Yourself: While personal loans are different than student loans, they can still be used to invest in yourself in other ways. If you’re looking to build a new skill, learn a trade, or purchase equipment, you might need a large sum of money up front.

  • Small Home Improvement Projects: If you want to tackle a home improvement project, you can get the funds you need through a personal loan. These loans are great for small projects, like a bathroom renovation, new flooring or kitchen upgrade.

  • Emergencies: Sometimes you’ll find yourself suddenly needing a large sum of money for something unexpected, like a car breaking down, pet getting sick or appliances not working. If you don’t have the money to cover this emergency, you can use a personal loan to help you pay for it right away.

How to Get a Personal Loan

  • Know Your Credit: The first step to getting a loan is knowing your current credit situation. Pull your credit report from the major credit reporting agencies and read through that information. You can get a free copy of your credit report each year from each of the major credit reporting agencies.
  • Pay Down Debt: Once you know where you stand, you may need to make your credit profile more favorable to lenders. If your debt-to-income ratio is too high, you may need to pay down your debt to get the loan you want. Put together a plan to pay down your debt before you apply, if that is possible for your current situation.
  • Get Quotes: It’s always a good idea to shop around before applying for a loan. Do your research and get several quotes before you make a decision. You’ll want to find the right quote and the right lender for your financial situation.
  • Submit Your Application: Once you’ve decided on a loan, you’ll submit your application either in person or online. This will include submitting any documentation the lender requires.
  • Receive the Funds: If you receive an approval for the loan, you’ll then receive the funds. During the application process, you’ll likely have an opportunity to let your lender know where you’d like the funds deposited.

What You Need to Know: Mistakes When Borrowing

  • Borrowing More Than You Can Afford: Set yourself up for success by only borrowing what you’ll be able to afford. You want to make sure that you’ll be able to make each monthly loan payment, so you’ll need to have that money available each month.
  • Not Knowing Your Budget: You’ll always want to take your budget into account before you make a purchase or apply for a loan. This is the best and easiest way to understand what you can afford each month.
  • Refraining from Shopping Rates: You don’t want to get stuck with a less-than-favorable rate or lender, so it’s always best to do your research before you apply for a loan. Always take the time to look around and get quotes before you apply for a loan.

Alternatives to Personal Loans

  • Credit Cards: You can look into getting a credit card to help you pay for the things you need up front. Credit cards are a great alternative because they’re revolving credit, so you’ll pay off your balance and continue to have access to that credit line.
  • Cash-Out Refinance: This is where you take out a new mortgage for more than you currently owe on your house. The difference between your new mortgage and what you owe can be used to pay for other things you may not be able to afford right now.
  • Home Equity Line of Credit (HELOC): This is a line of credit that is secured by your home. It gives you a credit line that you can use to pay for something you might need and then pay it off. Like credit cards, this is a revolving account that you can use again as you pay it off.
  • Home Equity Loan: Like a HELOC, this is money you receive that is secured by the equity of your home. Unlike a HELOC, this is a set amount of money that you receive and is paid off over a specific period of time.

Next Steps with Merrick Bank

While Merrick Bank doesn’t offer any personal loans, we are happy to be your financial partner as you build or rebuild your credit. You can use our secured or unsecured credit cards to help you get in a good place to be approved for a personal loan that will work for your needs and help you reach your financial goals.