Personal loans refer to relatively quick sources of cash that are offered to individuals (rather than small businesses or large enterprises). Most personal loans are structured in a way where you gain a lump sum of cash upfront (called the principal) which is then paid back over time in installments with interest. Personal loans can be offered for a specific purpose (such as debt consolidation) or can be used at the borrower’s discretion.
There are many ways you can obtain a personal loan. In this article, we look at some of the most common options that borrowers have when in need of capital.
Table of Contents
- Different Types of Personal Loans
- Common Sources of Personal Loans
- Smart Strategies for Personal Loan Approval
- Final Thoughts
Different Types of Personal Loans
Borrowers have a wide variety of choices available to them when it comes to personal loans. Depending on your personal needs and the institution you approach for your loan, you can select from several different loan structures and characteristics. Some of the most common types of loans include:
Unsecured personal loans
Most personal loans are offered on an unsecured basis, meaning the borrower does not have to put up any collateral for the loan. These loans are provided based on the borrower’s ability to repay through their monthly income from their job and/or business venture. While these loans do not carry the risk of personal assets being seized, they do come with a higher interest rate than a secured loan because of the additional risk that the lender undertakes.
Secured personal loans
Secured personal loans require the borrower to put up a personal asset as collateral before the lender advances the funds. These loans provide access to capital for borrowers with lower credit scores, and carry a lower interest rate than unsecured loans - this is because the lender’s risk is protected by the value of the asset. In the event that the borrower fails to repay their obligations, the ownership of the asset transfers to the lender, who can sell it on the market to recoup the amount owed.
Fixed-rate loans are loans that charge a single rate of interest throughout the life of the transaction. Regardless of changes in the external environment, the interest rate charged to borrowers does not change at any point. This enables the borrower to budget effectively as they repay the same amount of principal plus interest in each period.
Variable rate loans
Variable-rate loans have an interest rate that fluctuates based on the movements of an underlying benchmark (usually the “prime rate”). As this benchmark moves up or down, the interest rate charged on the loan also changes.
Personal line of credit
Also called a revolving loan, this type of personal loan lets the borrower borrow, repay, and borrow again up to a certain limit. For example, imagine a personal line of credit with a $10,000 limit. If a borrower draws down $6,000 of this $10,000, they only pay interest on that $6,000 and have the capacity to borrow $4,000 more if needed. In a month, the borrower pays back $2,000 of the amount borrowed. At that point, the borrower will only pay interest on $4,000 ($6,000 minus $2,000) and can borrow $6,000 if needed.
Buy now, pay later
In recent times, several online companies have begun to offer a “buy now pay later” solution at the point of sale of e-commerce websites. This type of loan advances the borrower funds to purchase their item(s) from e-commerce sites and pay back the borrowed amount over time in installments.
Common Sources of Personal Loans
There are several ways that you can obtain personal loans.
In Canada, there are six major retail banks (known as the Big Six) that offer a wide range of personal loans, including both secured and unsecured loans, fixed or variable rate loans, lines of credit, etc. The interest rate you get on loans from retail banks can often vary depending on the relationship you have with the bank and your credit score.
A credit union is an institution that is collectively owned by its members who are often part of a community or a specific type of occupation. All else being equal, credit unions can often offer lower interest rates or waive certain fees for borrowers compared to retail banks, as they are structured as non-profit enterprises.
Online lenders are private lenders that do not have a physical branch presence. Loans are applied for, received, and administered fully online. These types of alternative lenders can often be helpful for people that currently do not have a high enough credit score for retail banks, and/or are looking to rebuild their credit. However, borrowers should be advised that it is best to do extensive research when obtaining an online personal loan and work with trusted lenders in the space.
Credit cards offer advances, which are effectively cash loans made on your credit card limit. While these are easy to qualify for and obtain, they can become highly expensive over time, with annual interest rates charged at 20% or even higher.
Peer-to-peer lending is a relatively new form of financing facilitated by specialist online platforms where individuals can borrow money from other individuals, thereby eliminating the need for an institution such as a bank.
Smart Strategies for Personal Loan Approval
Before approaching a lender for a loan, there are several strategies you can follow to optimize your chances of approval.
Pull your own credit report and assess if there are any errors that you need to fix
Pay back any late or missed payments as soon as possible
Try to increase the size of your credit limit (if possible). Your credit availability and utilization rate are key factors in your credit score calculation
Ask only for the amount that you need
Personal loans can be used for a wide variety of purposes – whether they be large purchases, emergency expenditures, or simply to help you run your day-to-day life. While banks are a common source of personal loans, online lenders can be helpful if you need greater flexibility, or if your credit score does not qualify for a bank loan.
At Magical Credit, we have worked with thousands of borrowers with their unique personal loan and financing needs. Contact us today to learn more about how we can help you on your financial journey!