A personal loan refers to money borrowed from a bank or credit union that is used by the borrower to serve various purposes and paid back in monthly instalments. The interest rate you pay is dependent on your creditworthiness, which is determined by assessing your credit history, income, and existing debts.
Purpose of personal loans
Personal loans serve a multitude of objectives that allow for optimal financial flexibility. In this section, we'll be comparing personal loans and what purposes they can be used to serve.
- Debt consolidation. If you're facing financial troubles due to multiple loans or outstanding credit card debts, a personal loan allows you to pay off such debts at lower interest rates. By grouping various debts, you can easily work around a more flexible time frame for paying off your balances and work within your current financial capabilities.
- Home renovation. Whether it's to fully remodel your home, install several pieces of major equipment, or cater to emergency home repairs, a personal loan can eliminate the need for having a large amount of cash on hand. Especially for homeowners without equity, personal loans will involve less risk when they are unsecured and therefore don't require you to offer your home as collateral.
- Emergency costs. Sometimes, unforeseen circumstances such as an accident or death will require you to take out a personal loan if you can't immediately cover the expenses for medical bills or a funeral. If, for example, the deceased person's estate cannot cover outstanding medical expenses or funeral services, you can satisfy these fees and charges with a loan.
- Large purchases. Whether to purchase a brand new vehicle, fund a dream holiday or pay for a glamorous wedding, a personal loan can be used to shoulder big-ticket items. Rather than saving up for months or even years to purchase a major item on your wishlist, you can choose to acquire it immediately, accommodating repayment over a fixed period with a personal loan.
- Education. Enrolling in a program at university or pursuing further studies doesn't come cheap. Not everyone can afford to shoulder tuition and living expenses every year, but personal loans offer an easy and immediate solution.
- Business start-up. Among one of the most popular reasons to apply for a personal loan is starting up a business. If you've taken up too much time trying to save capital and haven't experienced a breakthrough, applying for a personal loan may be your best bet towards success. A business credit card is an alternative for businesses with an established trading record.
Requesting a personal loan is a major financial step. Whether you're applying for a secured or unsecured personal loan, you will be expected to meet certain eligibility criteria (including Australian citizenship or residency) in order to qualify. Temporary residents can also be eligible for personal loans but may have to adhere to additional criteria. All applicants will need to supply details of:
- Income. Regardless of the lender you choose to work with, applicants are almost always expected to have a steady source of income. This ensures that you're capable of repaying monthly instalments without any delays.
- Employment. Secondary to proof of income, you may need to be employed full-time in order to qualify for the best personal loan options. Part-time workers and the self-employed can also apply, however. In some cases, unemployed applicants can be considered for a loan if they receive government benefits.
- Existing debts. The lender will want details of your existing debts so that they can make sure you can still afford to repay a new debt.
- Credit score. Perhaps one of the greater considerations lenders make when considering loan applicants is their credit score. Naturally, those with higher credit scores will be able to reap the benefits of lower interest rates and larger borrowing amounts.
Types of personal loans
Though the majority of personal credit union or bank loans are unsecured and come with fixed payments, there are also other types you can consider that range in terms and qualifying factors. Here, we'll compare personal loans and their implications.
- Unsecured vs secured. The most popular type of personal loan are unsecured since they don't require collateral in the form of your home, vehicle, or other properties. Whether or not you qualify and receive a low interest rate will be determined primarily by your credit score and debt-to-income ratio. On the other hand, secured personal loans adhere to opposite guidelines. Lenders can legally seize your collateral if you default on your loan.
- Fixed interest rate vs variable interest rate. As its title suggests, a fixed-rate loan charges you monthly rates and payments that never change for the duration of the loan. If you're concerned about the rising rates linked to long term loans and would rather maintain consistent payments, fixed-rate loans are usually easier to budget for. Alternatively, variable rate loans demand charges that fluctuate according to how benchmark interest rates rise and fall. Variable rate loans make the most sense for borrowers who are looking to pay off a sum in a shorter period of time, as rates less likely to surge at short notice.
Alternatives to personal loans
Before applying for a personal loan, consider these alternatives which might better suit your situation:
- Balance transfer credit card. A new credit card with a 0% interest offer for an extended period on balances transferred to the card (from your existing credit cards and/or personal loans) may be a good alternative for debt consolidation, or immediately following a major purchase on your existing credit card.
- Credit card with 0% on purchases offer. If you're contemplating a major purchase (such as home appliances, technology or a holiday) you could apply for a new credit card with a 0% interest offer on purchases for up to 15 months, sometimes longer.
- Bank overdraft or line of credit. The benefit of this type of finance is that you don't need to draw down the full amount for your needs upfront. You just use the credit as you need it, which means that you're not paying interest on the entire loan amount, just the amount you've used to date.
- Refinance your home loan to make use of equity. If you have a reasonable amount of equity in your home, you could consider refinancing it for a larger amount than your remaining loan balance. This gives you access to cash which you could use for any purpose normally covered by a personal loan, but be aware that in so doing you are converting short-term debt into long-term debt.