When it comes to personal loans, there’s much to learn and understand. What sets a personal loan apart from other more common types, like auto loans and mortgage loans? What are the typical uses for personal loans? And are there viable alternatives to consider?
To help answer these and other crucial questions, Investopedia recently engaged in a conversation with Dr. Linda M. Hooks, the head of the Department of Economics at Washington and Lee University in Lexington, Va. Dr. Hooks, who boasts a rich background in conducting and publishing research across various economic domains, offered valuable insights into the realm of personal loans. Here’s a recap of the informative discussion:
Unraveling the Distinction of Personal Loans
Investopedia began by seeking a clear understanding of personal loans and their differentiation from other loan categories. Dr. Hooks described a personal loan as a fixed-payment loan tailored for individual consumers. Borrowers acquire a sum of money and commit to repaying it over a specific timeframe through consistent monthly installments, similar to auto and mortgage loans. However, what sets personal loans apart is that they often do not necessitate collateral or the pledge of a valuable asset, like a car or a home, to secure the loan.
Versatility in Utilizing Personal Loan Funds
Dr. Hooks highlighted the versatility of personal loans. These loans can facilitate a range of purposes, from financing substantial acquisitions that exceed available cash reserves, such as new appliances or air conditioning units, to consolidating existing debts. They also serve well for addressing one-time expenses, including medical bills, educational costs, or even funding a special trip.
Qualifications and Credit Scores in the Personal Loan Landscape
To apply for a personal loan, a solid credit history is typically the primary requirement, much like many other loans. In certain cases, collateral may be used to secure a personal loan, potentially improving one’s qualification or securing more favorable loan terms. Dr. Hooks recommended inquiring with one’s bank about the types of collateral that could be accepted, which might include assets like savings accounts or insurance policies.
Understanding Credit Scores and Where to Find Them
As for obtaining one’s credit score, Dr. Hooks pointed out that it usually involves a fee. Nevertheless, she noted that individuals can access their credit report for free through AnnualCreditReport.com, and the information contained in the credit report forms the basis for the credit score. In many cases, reviewing the credit report for accuracy may suffice without the need to obtain the actual credit score.
Crucial Factors Influencing Loan Amounts and Approval
Lenders determine the amount an individual can borrow based on their credit score and other considerations, including potential collateral or pre-existing financial relationships.
If a personal loan application is rejected, borrowers have the right to know the specific reasons behind the denial, enabling them to chart their next steps. Frequently, denial can be attributed to a low credit score, which is a situation that can be improved. Dr. Hooks recommended strategies for enhancing one’s credit score, such as consistently paying bills on time and exceeding the minimum payment required on credit cards. Moreover, keeping credit card balances well below the maximum limit is advisable.
Early Repayment, Co-Signers, and Exploring Alternatives
While the possibility of early repayment of a personal loan varies based on the loan’s terms, Dr. Hooks underscored the importance of clarifying any potential penalties for early repayment before agreeing to the loan.
She also explained the concept of co-signers, individuals who commit to repaying the loan if the primary borrower cannot. Co-signers can be a valuable resource for those with limited credit histories, but they should be aware that they bear full responsibility for the loan, which can also impact their credit history and score.
Exploring Alternatives to Personal Loans
Dr. Hooks advised that when it comes to alternatives, individuals could consider options like home equity loans, credit cards, or simply saving up for planned expenses and making the purchase once sufficient funds are accumulated.
Protection Measures for Borrowers
In the event borrowers suspect their lender is involved in illegal or unethical practices, they have the recourse to file complaints with the Consumer Financial Protection Bureau (CFPB). This agency, established under the Dodd-Frank Act of 2010, provides consumers with resources and channels for voicing grievances related to financial services.
Managing Financial Hardships
If financial difficulties arise and impede the ability to meet loan payments, Dr. Hooks recommended reaching out to the lender as soon as possible. Federal government programs may offer assistance, and information on such programs can be found on the CFPB website.
Concluding Insights
In conclusion, Dr. Hooks advised individuals to weigh their options carefully when considering a personal loan. Depending on the circumstances, it may be more advantageous to forgo a personal loan in favor of qualifying for a home mortgage, for instance.
The discussion offered valuable insights into the realm of personal loans, shedding light on terms, qualifications, and alternatives, and underlining the importance of maintaining a good credit history.