A personal loan is an unsecured loan, meaning that it is a loan without collateral. Collateral is a lien on an asset (usually a large asset, such as a home or a car), used to protect the lender from the threat of bankruptcy or insolvency in the borrower. With a personal loan, if the borrower does file bankruptcy, the lender can not immediately seize the assets of the borrower.
A personal loan, since it is unsecured, will carry a higher interest rate than a loan secured by collateral. However, interest rates for a personal loan are still lower than the rate of a credit card (after the teaser rate).
A fixed term is usually written into the terms of a personal loan. Unlike a credit card,the loan must be paid within a specified period of time.
Carrying a fixed rate is the standard practice for a personal loan. A fixed rate is an interest rate that does not change over the life of the loan. (Contrast the variable rate, which does change the interest rate over the life of the loan.)
Personal loans carry no tax benefits. Neither the interest nor any principal payments are tax deductible over the life of a personal loan, unlike a home equity loan or a mortgage.
A personal loan may be given by a financial institution to a borrower, but most personal loans take the form of family or friends serving as the lender to a debtor. Even if a personal loan is not given by a business to a borrower, if a personal loan is given person to person with the expectation of repayment, the loan is legally binding. Personal loans in which the terms were initially unclear are cause for much litigation in small claims court, and anyone considering giving a personal loan is advised to write all terms down on paper and agree to the loan terms with a signature from both parties.
Debt consolidation
Debt consolidation is the practice of taking out one loan to pay off many loans. There are many types of loans which may be used to consolidate debt depending on the creditworthiness, employment history, and personal assets of a borrower.
Debt consolidators do business by buying the loans of borrowers in financial hardship at a discount (either a part of the total loan due is forgiven or the total amount due remains the same, but the interest rate is lowered.) Debt consolidators will then pass along the savings to the borrower. The consolidators will also lengthen the term of the loan to the borrower in order to ease the immediate financial burden on the borrower to better insure payment.
Debt consolidation loans are usually secured by collateral. The most common types of consolidation loans involve ownership of a house and are known as home equity loans or second mortgages. However, in certain instances, a personal loan can be taken out to consolidate debt.
Advantages of a personal loan for debt consolidation
A personal loan can be quite advantageous to a borrower although they are much harder to get from financial institutions. A personal loan being an unsecured loan, it provides peace of mind to the borrower knowing that assets cannot immediately be seized upon correctly declaring bankruptcy or a default on the loan.
A personal loan is usually the best solution for a person without ownership of a home (or very little equity in a home) and in immediate need of financial assistance.
The personal loan must be paid off within a certain period of time, which forces discipline on the borrower.
The interest rate on a personal loan is less than the interest rate on a credit card; therefore, consolidating credit card debt or cards into a personal loan carries financial advantages.
Disadvantages of a personal loan for debt consolidation
Though a personal loan provides peace of mind and some financial flexibility for borrowers without assets, there are disadvantages to consider.
The personal loan interest payments are not tax deductible.
Though the interest rate on a personal loan is lower than a credit card, it is still higher than that of a secured loan. Secured loan interest rates are usually around 5 or 6 percent, while the interest rate of an unsecured loan typically averages 10 or 11 percent. Borrowers will pay much more by the end of term on an unsecured loan than on a secured loan.
Though a borrower does not have to place a lien on any assets with an unsecured loan, loss of goodwill, in both business and personal interests, often accompanies defaults.
Where to get a personal loan for debt consolidation
Large financial institutions offer personal loans for debt consolidation; however, they are much harder to get than secured loans. Some factors which may help procure an unsecured loan include good credit, stable job history, verifiable income, membership in a credit union, other accounts held within the financial institution, and personal goodwill. Personal loans may also be offered from friends and family.
