Whether you’re looking for extra money to pay for that vacation or are considering investing in a home addition, a personal loan can be a great funding option. You can get the lump sum of money you need right now and pay it back over time. Understanding exactly what this type of loan is can assist you in determining whether or not it’s the right funding option for you.
What Is A Personal Loan?
A personal loan is a type of loan provided by a lending institution that is typically unsecured. This means they are not holding any collateral, such as a vehicle, in the case that you would default on the loan. For this reason, loans used for personal purposes can be awarded with higher interest rates than secured loans.
When you apply for this type of loan, you ask for a lump sum amount of money from the lender. In exchange, they will provide you with a fixed repayment schedule and interest rate. Once you sign the loan agreement, you’ll receive the lump sum of money. Typically, each month you’ll submit a payment to the lender for as long as the determined term of your loan. For example, you may be expected to pay $50 per month for a term of 3 years.
What Are Bank Loans Used For?
This type of loan is used to fund a variety of purchases. Since there is usually no collateral requested, you can essentially fund the purchase of anything you would like with the money. Some common reasons people apply for this type of loan include:
- To Pay An Emergency Expense
- Unexpected Car Repair Bills
- Last Minute Vacations
- Medical Expenses
- To Pay Off A Credit Card With A High Interest Rate
- Home Remodeling
- To Cover Moving Costs
- Pay For Large Purchases (Appliances, Car, Etc.)
- To Fund Your Wedding
How Do I Apply For A Bank Loan?
There are many financial institutions that offer loans for personal use. You may have done some research on various institutes to figure out what their available interest rates are. Many banks will state that they have certain credit requirements you must meet.
Banks know that loaning a borrower money comes with risk. The person can agree to pay back the loan according to set terms. However, they may face a financial or medical problem in the future that can make it impossible for the borrower to repay the loan. In this case, the lender, essentially, loses their money. Therefore, every lender is careful to assess the quality of the borrower before approving a loan application.
The Five Cs Of A Credit Worthy Borrower
While every financial institution has its own standards that a borrower must meet to be creditworthy, they all base decisions on five main areas. By taking the time to understand what these five credit areas are, you can position yourself to look like a prime borrower.
Your credit history is like your report card. It shows how you’ve managed your credit over the years. If you obtain a copy of your credit report from any of the three major credit bureaus, you’ll see a list of all the accounts you’ve had for the past 10 years.
Each credit account you have will show your payment history and amount of debt you owe. TranUnion, Equifax, and Experian all provide individual credit scores to consumers. Your credit score is a number between 350 and 850 that sums up your creditworthiness. Those who regularly pay their debt bills on-time will have a credit score closer to 850. Those who regularly miss payments and even default on their financial obligations will be rewarded with a score closer to 350.
Many banks will set specific credit scores that a borrower must have to be eligible for a loan. They’ll also set specific interest rates depending on an individual credit score. For example, those with a credit score of 800 or higher may receive a four percent interest rate, while those in the 750 to 799 credit score range may receive a five percent interest rate.
Lenders will look at your capital to determine if you’re a safe borrower. Your capital includes your savings, properties, retirement account, and investments. The more capital you have to your name, the more secure you’re going to be as a borrower.
Banks want to know that the money they fund you with will be safely repaid. While your financial situation may look good right now, financial setbacks can occur in the future. You may lose your job and not have liquid money to pay back your loan.
In this case, the lender will sue you to take possession of your assets for repayment. The more assets you have to your name, the safer you are to the bank. This is because they know they’ll be likely to get their money back through your assets if you default on the loan.
Every borrower’s capacity to repay their loan is going to be evaluated by a potential lender. This is typically calculated with a debt-to-income or DTI ratio. They want to ensure you make enough money to cover all your previous financial commitments and the new loan.
When you submit your credit application, the lender will ask you to upload pay stubs so they can see how much money you make a month. They’ll ask about monthly expenses like your rent and take a look at what other monthly debts you owe payments on. The lower your DTI ratio, the more likely a bank is to approve you for a loan. This is because your current financial commitments are much less than the money you bring in each month.
In some cases, a loan lender may ask you to provide collateral for the loan. Collateral is defined as a personal asset that you own, which you’ll hand ownership over to the bank in the event you default on the loan. Collateral can be a car, home, or savings account.
Most individuals can apply for a loan without having to give collateral. However, if you have an unfavorable credit history or not a lot of capital to your name, they may require collateral to approve the loan. This collateral helps the lending institution to mitigate some of their risk of lending you money.
Conditions is a broad term used to describe a variety of factors a lender may consider before extending you credit. Apart from the four major factors above, your lender will look for conditions that may affect your financial situation.
Conditions can include factors like what you’re using the loan for, how market conditions can alter your ability to repay in the future, and how many financial products you’ve used with them in the past successfully. Each lender is going to have their own unique list of conditions they will evaluate upon your loan application.
The Application Process
When you decide what financial institution you’re going to submit your loan application with, you’ll want to ensure you meet their creditworthiness standards. Most banks will specify that you’ll need a credit score above a certain number to apply.
If you meet the credit requirements, you’ll want to fill out the entire application. Most banks offer online applications as a convenience for customers. Expect to upload copies of your pay stubs, driver’s license, and mortgage or rent statements. You’ll be asked to specify your desired loan amount and term.
Receive Terms And Conditions
The credit institution will evaluate your application and decide whether or not they’re going to approve your application. If you fit their borrower requirements, they’ll send you a term sheet. This will state the total amount they’ll fund, the interest rate, the term, and any fees or penalties you should be aware of.
As a borrower, it’s important to look over all aspects of this terms and condition sheet. The lender may have approved you for more loan funds than you requested. It’s best only to borrow what you need. So, you may ask the lender to reduce the loan amount to one that fits your needs. This is your chance to go back and forth with the lender to craft terms and conditions that fit your liking.
Finalize The Loan
If you accept all of the terms and conditions, then it’s time to finalize the loan. You’ll typically do this by signing a loan term agreement sheet and submitting it back to the lender. Upon receival of the finalized document, the lender will deposit the lump sum loan amount into your bank account. You’ll be expected to pay your monthly loan payments for the term specified in your agreement.
You’ve likely learned a lot about the bank loan process above. Now, let’s take a second and summarize all that knowledge into easy, actionable steps.
1. Evaluate The 5cs Of Your Credit
2. Check Bank’s Loan Requirements
3. Submit Your Application And Requested Documentation
4. Read Over And Negotiate Loan Terms And Conditions
5. Finalize Loan Documents And Receive Lump Sum
Applying for a loan can be very easy to do when you understand the process. Is there any part of the loan process that scared you before reading this? If so, how has reading this article helped to ease that burden of stress?