What Is a Personal Loan?

A personal loan is borrowing a sum of money from a financial institution for personal use. Individuals may use the money for almost anything; some examples are a vacation, a car, home improvements or bill consolidation. The borrower will make monthly payments to the financial institution repaying the sum borrowed plus interest. Personal loans give individuals the financial ability to make purchases without saving the funds first.

Types

Financial institutions offer a variety of personal loans. There are fixed interest rates, where the monthly payment stays the same for the term of the loan. Variable interest rates may seem more attractive at first, because the initial interest rate is usually lower than fixed rates. However, the banks can adjust variable interest rate loans and if the interest rate rises, so does your monthly payment. Unsecured loans do not require collateral from the borrower. If the borrower fails to pay, the bank has nothing to repossess. A secured loan requires some type of collateral, and the loan amount is usually a percentage of the value of the collateral. If the borrower fails to make payments as agreed, the bank can take the collateral.

Time Frame

Unsecured personal loans are typically from 12 to 48 months. Secured personal loans vary depending on the type of collateral. Cars may have terms from 36 to 72 months and home equity lines may be much longer. The buyer's preference, bank rules and type of loan usually determine the term of the personal loan.

Size

Dollar amounts depend on what the financial institution offers, the borrowers credit and value of the collateral. Typical unsecured personal loans begin at $500, and most banks top out around $25,000. The amount of a secured personal loan is typically a percentage of the value of the collateral. However, the risk perceived may also affect the size of the loan.

Considerations

Most banks offer a variety of application methods including Internet, phone and handwritten applications at a branch office. Incentives may be offered to individuals to set up payments automatically deducted from a bank account each month. Other banks send monthly statements or provide a book of payment coupons. Internet banks may offer to direct deposit the amount borrowed into a borrower's account at any financial institution, or pay off other debts directly.

Warning

Unsecured personal loans usually have significantly higher interest rates than secured loans. An individual with a secured personal loan, who fails to make the agreed upon monthly payments will have the collateral repossessed by the bank. The credit bureaus will be notified of defaults as well, affecting an individual's future credit rating. When not secured by a home, interest paid on personal loans is not income tax-deductible.

Resources

• Money Central Personal Loan Rates
• Bank Rates