Personal Loan Definition
There are several types of personal loans. Among the most common personal loans are mortgages for houses and automobile loans. Such loans use the merchandise purchased as collateral, or a guarantee against failure to pay the loan. It is generally much easier to get a personal loan of any nature with substantial collateral, high income and good credit. However, it is possible to get loans with less favorable credit profiles if consumers are willing to accept higher interest rates.
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General Definition of a Personal Loan
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The major characteristic of a personal loan is a debt incurred by an individual consumer rather than a business loan or line of credit granted to a company or corporation. Mortgages are usually the largest debt that individuals incur in a lifetime, although some educational loans are also quite large--especially for post baccalaureate education. Automobile loans are another common type of personal loan. Personal loans can be obtained from banks or finance companies. Bank loans are usually the most difficult to qualify for, requiring significant collateral, substantial income and a favorable credit rating in exchange for lower interest rates and more advantageous payment schedules. Short-term loans and credit cards require no collateral but offset this convenience by charging high interest rates, imposing restrictive payment terms, or both.
Traditional Versus Subprime Mortgages
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The financial crisis that was a major factor in deciding the 2008 United States presidential election was preceded, and perhaps precipitated by a collapse in the American housing market. Before the market crisis, many consumers who would otherwise have failed to qualify for traditional mortgages were able to buy houses by obtaining subprime mortgages.
Traditional mortgages are based on a conservative percentage of a customer's income (approximately 30 percent) and require substantial down payment and a good to excellent credit rating. Payments are based on principle and interest, with payments toward the principal building equity for the homeowner.
Subprime mortgages typically carry higher interest rates, which reflect the less favorable credit profiles of many but not all of the consumers who use them to purchase their homes. Some subprime mortgages base early payments only on interest, and therefore homeowners fail to build equity in their homes. Such loans frequently carry adjustable interest rates, which increase dramatically after an initial very low rate. Such increases, coupled with a lack of equity against which strapped homeowners could otherwise borrow against, often lead to foreclosure and repossession of the house.
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Automobile Loans or Leases
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Automobile loans represent a second very common type of personal loan. Like a mortgage, where the house serves as collateral, the automobile serves as collateral for a car loan. However, since automobiles generally depreciate rather than increase in value, the car owner never builds equity. Instead, after the term of the loan is over and the car is paid, the paid-off car can be traded in as partial payment against the purchase of a new car. Many thrifty car owners keep their paid-off cars and save or invest the windfall that represents their former car notes.
Leasing a car works much like renting an apartment. An automobile lease never gives the driver ownership of the car, merely the right to utilize it freely during the term of the lease. Often there is a closing payment required at the end of an automobile lease term in order to close out the contract. Some drivers prefer leases because they are relieved of the necessity of selling or trading in the old car when they desire a new one.
Other Personal Loans
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Personal loans can be obtained for nearly any purpose. Home remodeling is a common reason for taking a personal loan. Educational expenses are another. Such loans may be more difficult to obtain unless the borrower can provide substantial collateral, because there is no inherent value to the lender in the item for which the loan is being obtained. However, loans for jewelry, coins, art and similar goods are often made on much the same basis as mortgages or automobile loans, with the goods themselves serving as collateral.
Credit cards represent a very common type of unsecured loan. In exchange for monthly payments that include interest (and represent profit for the credit card company), consumers are allowed to space out payments for large and small purchases over time rather than paying for goods out of pocket. Charge cards like a conventional American Express card work much like net-30 invoices, delaying payment in full for a short period rather than spreading payments over time.
Short-Term Loans
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Many individuals who can't qualify for conventional loans or credit cards--due to low income, poor credit rating or both--turn to short-term loans. Such loans are often known as "payday loans," reflecting the common requirement to show regular employment as a condition for obtaining the loan. Short-term loans are a type of "signature" loan, so named because they are not based on collateral but rather a signed contract stating that the debtor promises to repay the lender. Such loans often carry extremely high interest rates and have repayment schedules as short as 2 weeks, with hefty penalties for missed or late payments. Many states have moved to regulate or even outlaw such loans in an attempt to protect their citizens from unscrupulous lenders or burdensome levels of escalating debt.
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