How Personal Loans Work & Common Traps To Avoid

June 8, 2019

If you’re thinking about taking out a personal loan, you’re not alone. In fact, you’re part of a growing group of Americans who are utilizing these for a wide range of reasons. However, even with more people borrowing than ever before, it’s important not to take this decision lightly. Education on how personal loans work and common traps that borrowers fall into can help you avoid potential mistakes that could be costly.

How Do Personal Loans Work?

Most people take out personal loans when they need money but don’t want to take out a credit card with a potentially high-interest rate. In order to take out this loan, you’ll need to apply with a financial institution and provide the information they require. The funds won’t be sent into your account until you are approved, which can take days or weeks depending on the institution.

However, before you sign on the dotted line for the application, it’s important to understand what you are agreeing to. The first is the type of loan that you’re applying for, which can be secured or unsecured. With a secured loan, you will have to provide collateral (such as a car title for an auto title loan). With an unsecured loan, which is the most common, you do not have to provide collateral but do have to provide detailed personal financial information.

With most personal loans, you’ll have a fixed rate on the money you borrow. This means that your monthly payments will continue to be the same until the loan has been satisfied. This is different from most credit cards, which tend to have payments that change over time. The interest rate you get, in particular, will depend on many factors. According to Finance43, this can range anywhere from 5% to over 35%, with most people being able to secure one somewhere in the middle.

Reasons to Borrow

Emergency Situations
Debts
Student Loans
Weddings
New Car

Traps You Must Avoid

When taking out a personal loan, the following traps can cost you unexpected money. This is why it’s so important to read the fine print on all applications and discuss any loan in an in-depth manner before applying. This is a decision that should be met with adequate research on your part.

1. Extremely High-Interest Rates

Some financial institutions charge extremely high-interest rates, which can make it difficult to pay off the loan in full. To ensure you’re getting the very best rate out there, it’s crucial to shop around and compare the rates offered by different companies. If you find that rates are continuously high, then you may want to reconsider the cash loan and look for a credit card that has better terms. This is where research and comparison shopping is the most important, especially before you agree to borrow money.

2. No Credit Check Required

Any company that doesn’t require a credit check is likely to charge you interest rates higher than others. In addition to this, they will very likely charge you extra fees and penalties that could make it difficult to pay off the loan overall.

4. Penalties for Prepayment

Although it sounds unbelievable, there are some companies that will charge you a penalty for paying off your personal loan sooner than the final payment due date. Some companies even tack on the total interest you will owe to the loan amount right away, so you will still be paying full interest no matter how quickly you pay back. Look for information about penalties and interest in the fine print and don’t be afraid to ask questions.

5. Origination Fees

There are companies that charge origination fees, which will reduce the amount of money you receive. This can leave you just short of the funds you need, which means scrambling to find the rest of the money. Always research fees so you know how much money you’ll receive upon approval.

Using Your Loan Responsibly

Personal loans can be useful in situations where the money is needed quickly. However, it’s important to make sure you stay on top of payments each month. In the future, it’s recommended to create an emergency fund so you can avoid relying on banks that often charge high fees for this type of money.