It’s natural to skip over the terms and conditions when you use a new application or website. However, personal loans can result in hefty consequences if you aren’t aware of the important details. There are interest rates that can spiral out of control if not handled well and penalties if you fail to meet your loan repayment terms.
In this article, we’ll review what you should know about personal loan terms and conditions to stay informed of your options and avoid paying extra charges.
Interest rates and fees
Taking out a personal loan means you are expected to pay it back to the lender with interest, which is a percentage of your personal loan amount. The interest rate reflects how much extra you need to pay each year to repay your loan.
Here are the most common types of interest.
Fixed-rate personal loans have the same interest rate throughout the life of the loan. Personal loans can have widely different fixed interest rates between 2 and 36 percent, but once you’ve agreed to a fixed interest rate, it won’t change over time.
In February 2023, the average interest rate for personal loans was 11.47 percent.
Your monthly payments can fluctuate if your lender uses a variable-rate interest rate, which changes based on shifting market conditions and other factors. Instead of determining a single interest rate throughout the life of your loan, the lender might use the Federal Reserve prime rate to select their interest date each day.
The annual percentage rate (APR) is different from the interest rate. The APR represents, in a percentage, the annual cost you need to pay for borrowing the loan, which includes the interest rate and additional fees.
Compared to the interest rate, the APR is generally considered to give you a more accurate representation of the costs to expect when repaying your loan. It’s also typically higher than your interest rate.
What is a good interest rate for personal loans?
The average personal loan interest rate is around 10 percent, which is considered a decent interest rate. Anything lower than that is likely a good rate.
Depending on what kind of loan you’re seeking, your credit history, and other factors, the interest rate can soar above 30 percent.
The good news is that there are laws that regulate loans and help protect consumers. The Truth in Lending Act of Regulation Z requires lenders to truthfully disclose pertinent information in closed-end personal loans (i.e. loans that have a specified loan duration). When applying for a loan, you’ll be able to see the APR, late fees, number of payments, monthly payment amount, and if there are any penalties for prepayment.
What affects your personal loan interest rate?
Numerous factors influence your interest rate. Here are the ones lenders commonly take into account when deciding an individual borrower’s interest rate:
- Credit history
- Employment history
- Debt-to-income ratio
- Collateral value
- Loan duration
- Federal funds rate
- Loan amount
The higher the perceived ability you have to repay the loan, the more likely you are to be given a lower interest rate.
Repayment terms and schedules
Some lenders might be stricter with their repayment terms than others. In general, personal loans will allow you from 1 to 7 years to repay the loan.
Here are some common repayment schedules and conditions:
Fixed Monthly Payments: Every month, you will be expected to make a fixed payment until the end of your loan tenure, when the entire loan will be repaid.
Fixed Biweekly Payments: Similar to fixed monthly payments, except installations are paid every two weeks.
Balloon Payments: Regular payments are made, except there is a large one-time payment made at the end of the loan tenure. Having a balloon payment means you will have monthly payments that are easier to afford.
Early Repayment: If you repay your loan early, your lender may charge you an extra fee.
Auto-Pay: With online loan repayments, many lenders offer you the option to set up regular automatic payments. These can help you avoid missing a payment.
It’s common for borrowers to want to repay their loans early. However, lenders may impose a prepayment penalty if you repay your loan before your tenure ends. This penalty is typically around 1 to 2 percent of the outstanding principal balance.
These days, prepayment penalties have become less prevalent than before. However, it’s still a good idea to verify whether your loan terms include a prepayment penalty.
Late payment penalties and fees
Being late on your payments can result in having to pay late payment charges. These late fees generally cost between $20 and $50.
The good news is that many lenders will give you a grace period after missing a payment. This means you will have extra time before you are expected to pay any late fees. Lenders are also legally prevented from charging exorbitant late fees.
In addition to the financial implications of having to pay late fees, not making your monthly payments on time can also negatively impact your credit score. This can hurt your future ability to obtain personal loans.
The loan amount refers to how large the monetary lump sum you’re receiving when you take out a personal loan. Each lender has a different maximum loan amount they are willing to allow individuals to borrow from them.
If you have a good or excellent credit score, the lender is more likely to give you a greater loan amount.
For secured loans, the borrower’s loan amount will typically be up to half the value of the collateral. This means that if you offer $10,000 in assets as collateral, you will likely be able to borrow $5,000 from the lender.
Unsecured loans will take requirements like your credit score under extra scrutiny. Because unsecured loans don’t require collateral, it means that the lenders have a higher risk of losing money. That’s why it can be harder to get larger loan amounts in unsecured loans, especially if you don’t have excellent credit.
The loan duration is how long you have before you’re expected to have repaid the entire loan through regular payments. You might also hear the phrase loan tenure, which refers to the time period between when your loan is initially disbursed into your account and the date of your final repayment.
Generally, the longer your loan duration, the lower your monthly (or weekly) installment. This can help if you’re running on a tighter monthly budget. However, this may mean more money to repay in the long run once the interest rate and APR are factored in.
On the other hand, shorter loan durations mean you have less time to repay the loan, but you won’t have to deal with as many increasing costs over time.
If you end up repaying your loan early, you might need to pay an early repayment fee. That’s why when you are applying for a personal loan, make sure you have a clear idea of the repayment terms and how long you have to repay the loan.
For secured loans (AKA collateral loans), you’ll need to offer assets you own as collateral to back the loan. In case you default on the loan, the lender will have the right to seize those assets. This typically makes secured loans riskier than unsecured loans for the borrower. However, the benefit of secured loans is that they are often easier to obtain, which is important if you need to finance a car or house.
Generally, lenders will take valuable assets for collateral to secure the loan. Here are examples of assets borrowers may put up as collateral:
- A car title
- Savings account
- Future paychecks
Collateral can help you obtain mortgages, car loans, and other secured personal financing options. Lenders that may require collateral include banks, credit unions, online private lenders, auto dealerships, as well as pawn shop loans.
Credit score and eligibility criteria
A credit score is a three-digit number that represents your credit behavior and how likely you are to pay back a loan. It is determined by factors such as your credit history, how often you missed payments, and owed amounts. Here are the commonly accepted ranges of credit:
- 580 - 669: Fair
- 670 - 739: Good
- 740 - 799: Very good
- **800+: **Excellent
Lenders have credit score requirements. When you show interest in a personal loan, they can make an inquiry into your credit score to see how likely it is you are to repay the loan.
Some lenders will pre-approve you for a loan when you give them your basic information and show interest in obtaining a personal loan from them. This means that they will provisionally approve you. While pre-qualification doesn’t guarantee you will get a personal loan, it does mean your chances are fairly good.
For the pre-approval process, lenders usually perform a soft inquiry, which means that they get to check your credit report for informational and risk assessment purposes. This has no impact on your credit score.
When you officially apply for a personal loan, the lender will make a hard inquiry into your credit history. A hard inquiry does impact your credit score, usually causing it to dip slightly, but this is usually only a small influence.
If you’re planning on applying for multiple personal loans, be careful of lowering your credit score too drastically in a short time through hard inquiries–it can hurt your chances of obtaining a loan.
Loan disbursement process
If your loan application is approved, the loan disbursement process will be the final step wherein the lender gives you your funds. First, it requires you to sign the loan agreement. Remember to carefully read the terms and conditions before it becomes legally binding.
Disbursement can come in several forms, such as:
- Direct deposit into your bank account
- Check to your mailing address
- Wire transfer
- Cash disbursement
Loan renewal and refinancing options
A loan renewal essentially means you take out a new loan. You might encounter the same application fees when you renew a loan. This might be necessary if you have an outstanding balance at the end of your loan duration.
Potential benefits of renewing a loan include negotiating a lower interest rate, extending the amount of time you have to repay the loan, and consolidate debt.
Default and consequences
Defaulting on a loan means you’ve failed to make on-time payments for a lengthy period of time. This generally means you’ve missed several payments in a row for a few weeks or months.
If you’re only a few days late, there may be a grace period during which your loans are considered delinquent instead of in default. After that, you can expect to pay a late fee. Job loss, recessions, and delayed salaries are common reasons for borrowers defaulting on their loans.
If you suspect you might have trouble repaying your loan on time, it can sometimes be helpful to contact your lender and see whether you can negotiate altered repayment terms so you can get back on track.
Defaulting on a loan can have serious consequences, including:
Damaged credit score
Your credit report will reflect that you’ve defaulted on a loan for up to seven years. This can be a serious deterrent for future prospective lenders when they check your credit for another personal loan or credit extension.
Your lender might send your case to a debt collector, who will contact you continuously to ensure you repay the loan.
For unsecured loans, defaulting means you might get sued. It’s usually advisable to show up in court because judges rule in favor of the debt collector/lender in loan default claims if you no-show. This lawsuit can lead to severe consequences such as wage garnishment, property liens, and repossession of assets.
Repossession of your assets or foreclosure
If you default on a secured loan, your collateral will be taken by the lender to make up for the remaining outstanding balance. For mortgages or loans secured by property, the property may be foreclosed.
Bad relationship with the lender and co-signers
Naturally, the lender will be less willing to grant you future loans if you default on the current loan. However, it’s also important to consider the consequences for your co-signers. When you take out a loan with an inadequate credit score, a co-signer (usually friends or family) may advocate for your ability to repay the loan. If you default, the responsibility of the remaining balance goes to the co-signer, who might be upset by the debt they end up with.
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