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What is a personal loan?

We’ll explain everything you need to know about personal loans and how to get the best loan rate for you.

07 June 2022Lloyd Smith 8 min read
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Whether you need to pay for home renovations, business costs, or sudden expenses that came out of nowhere, a personal loan can be incredibly helpful.

One of the reasons why personal loans have become so popular is because most of them come with fixed repayment terms and interest rates. It's also easy to get approved for personal loans as long as you have a good credit score.

In this article, we take a look at everything you need to know for better understanding personal loans.

A personal loan is an amount of money lent to an individual by a bank, building society or other lender. You’ll be given the loan in one lump sum and will have to pay it back in monthly instalments over a set amount of time. When you repay the loan, you’ll be charged interest on the amount you’ve borrowed.

The personal loan rates can depend on the lender. There can also be some fees or charges involved with personal loans.

A personal loan can be borrowed from a lender for a variety of reasons. You can get a personal loan to pay for your wedding, renovations of your home, medical bills, vacation costs, or even for debt consolidation.

Though it's important to note that bank loans for personal purposes are different from instalment loans like car loans, home loans and student loans, which are all used for funding specific purposes like buying a car, getting capital for purchasing a home, or paying tuition fees.

Also, personal loans are different from a revolving line of credit like a credit card. With a credit card, you get a credit limit up to which you can use the credit card. As you make purchases with the card against the credit limit, the available credit gets reduced. You then need to make monthly repayments against the credit card in order to free up more available credit. When you have a personal line of revolving credit, it stays open indefinitely until you choose to close it down completely.

But with personal loans in Australia, the entire bank loan amount is disbursed to you together and there is usually a last date by which the entire loan has to be repaid.

In most cases, personal loans are unsecured loans which means you don’t need to put up a collateral for them. Lenders decide on whether you should get an unsecured personal loan or not based on a number of factors including the credit history, repayment history, currently open debt accounts, and credit score.

If you have a poor credit history or score and you don’t qualify for an unsecured loan, you can instead apply for a co-signed or secured loan.

In case of secured loans, you will have to back it up with an asset which needs to be of the same or higher value as the loan you are taking up. If you end up defaulting on your personal loan, the lender can repossess the asset.

In case of co-signed loans, an applicant, preferably with a strong credit history and credit score co-signs the loan application as your guarantee. They will also be responsible for any missed or late payments from your end.

After the loan has been approved, the lender will disburse the entire loan amount to your bank account and you can start using it. Your repayments will also start right away too. The lender will most probably report your loan account activity to the credit reporting bodies they are affiliated with.

Flexibility

Unlike other loans, personal loans in Australia are not intended for a single purpose. For instance, if you take a home loan, you can only purchase a home with it or if you take out a car loan, you can only purchase a car with it.

Personal loans are more flexible and versatile in nature, allowing you to use the loan amount for several purposes.

High borrowing limits and low interest rates

As compared to credit cards, personal loans are comparatively low interest rates with higher borrowing limits as well. This means, with low interest rate loans, you have to pay a lower interest amount, while still being able to borrow a bigger amount

No collateral requirement

When it comes to unsecured personal loans, you don’t need any kind of collateral in order to get approved. However, this may only be applicable if you have a good credit score and the loan amount isn’t too big.

Easy to manage

It's easier to take out one fixed rate personal loan and pay a single repayment bill every month, instead of using multiple credit cards. Multiple loans and credit cards with different interest rates, repayment due dates, and other factors are much more difficult to manage.

Build credit score

If you have a low credit score, a great way to steadily increase it is by taking out a small and affordable loan and then repaying it back on time. As you pay your loan instalments in a timely manner, your credit score will increase as well.

As discussed, personal loans can either be unsecured or secured. While unsecured loans are preferred by most borrowers, you may have to get a secured loan if the loan amount is too large or you are finding it difficult to get approved for an unsecured loan.

What is a secured personal loan?

With secured personal loans, you need to provide lenders or banks an asset as loan security. This can be a property, house, car, or any other substantial asset. In case you aren’t able to pay your loan back on time and you end up defaulting on the loan, the lender can seize the asset and sell it.

Though a big benefit of secured personal loan is that since you provide lenders with financial security, you get access to low interest rates and better loan terms. Moreover, secured personal loans for bad credit are also a great option if you have a low credit score.

What is an unsecured personal loan?

Unsecured personal loans do not require you to provide any kind of asset to the lenders. In case you are unable to repay these loans, the lenders can file a legal case against you in order to recover their money but they can’t seize any of your assets. Since lenders consider unsecured personal loans to be high risk, they have higher personal loan rates.

It's crucial that you compare personal loans before applying for one to make sure you are getting the best loan offer that fits your requirements and budget. Moreover, comparing personal loan offers also decreases the chances of your loan application getting rejected. Every time you send an application for a new line of credit to a lender, a hard inquiry is created on your credit report. Too many hard inquiries in a short span of time can affect your credit score and considering how long credit inquiries stay on the credit report, it can make it all the more difficult for you to get approved for personal loans.

Here are the main factors you should consider when comparing personal loans:

Interest rates: Personal loans charge a fixed APR (annual percentage rate) over the total loan amount. The APR can vary for individuals depending on their income, current open accounts, previous debt, and overall creditworthiness. Though, it's crucial to remember that personal loan interest rates in Australia can depend a lot on the lenders you are considering.

Monthly repayments/ EMIs: You need to make fixed monthly payments to repay your loan steadily. The monthly repayments or EMIs are calculated by adding up the principal amount and interest rate. You can lower your monthly payments by paying the loan for a longer period of time but that will also increase the interest amount you are paying.

Other fees: Some personal loans have other fees applicable on them as well like application fees, early repayment fees, missed payments fees, and monthly service fees. These can vary according to the lender which is why it is necessary to take them into account.

Loan term: It is the period of time during which you have to repay the loan amount in its entirety.

Early repayments: Some lenders allow you to make extra payments or pay the entire remaining loan amount in one go which can not only help you pay the loan off quicker but also save on interest. Though not all personal loan lenders offer this and some may even charge a fee if you want to close the loan account earlier.

1 - Check your credit score

Your credit score will determine the type of personal loans and loan offers you are eligible for. A higher credit score means you will have a better chance of getting a low interest loan with the best interest rates and terms. That is why before you apply for a loan, you should check your credit score to understand what kind of loans you can get.

2 - Check for pre-approved offers

Next, you should check for any pre-approved offers available to you through your bank. Usually, banks and other financial institutions run routine soft credit checks to understand your creditworthiness and provide loan or credit card offers accordingly.

With pre-approved loans, you don’t need to separately apply and then wait for approval. You get the loan amount instantly approved and disbursed into your account. Pre-approved offers also don’t hurt your credit score since there are no hard credit checks generated against them.

3 - Compare lenders

You should compare different loan products from different personal loan lenders before you finalise on one. Compare the loan terms, APRs, extra charges and the lender reputation as well.

4 - Submit loan application to the lender of your choice

When you have decided on a lender, submit the required documents to apply for the loan formally. You may be required to provide your bank documents and even salary slip to show proof of income.

5 - Receive the loan amount in your bank account

Once the loan application gets approved by the lender, you can expect to receive the funds in a few days and start using them for the main intended purpose. You will also have to start preparing for monthly repayments to avoid any fees or excessive interest.

Credit cards

Credit cards are the best option for people who need more options to pay and who aren’t sure how much credit they will need initially. The revolving credit limit and also the ability to make minimum monthly repayments when you can’t afford to pay the entire amount are also other factors that make credit cards an attractive option for lenders.

While the interest rates on credit cards are usually higher, you also get other perks like cashbacks, reward programs, and frequent flyer miles.

Take a look at our ‘How to choose a credit card’ guide to learn how you can choose the best credit card options.

Peer-to-peer loans

Peer to peer loans are similar to personal loans but instead of just going through one lender, you get funding from several lenders. Since you don’t directly work with a financial institution, the payment terms are more flexible and you may even be able to get a loan with a poor credit score. Though, peer-to-peer loans often have a higher interest rate.

There is no denying that personal loans can be immensely helpful when you require funds for sudden miscellaneous expenses. They can also help build credit history and improve credit score. But, before you apply for a personal loan, make sure to check your credit score to analyse what kind of loan offers you are eligible for.

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Written by Lloyd Smith

General Manager AU

Lloyd spreads the word about how awesome ClearScore is.