Personal loans fall in the category of unsecured debt, where people borrow money that attracts interest and is payable in installments over a specified period. You must apply for several things and be approved for a personal loan. Because a personal loan is not backed by collateral, they tend to have higher interest than secured loans. The great thing about personal loans is that you can buy whatever you want with the money you borrow, from a car to furniture or even property and should you miss a payment, the bank can't repossess your purchase.

The Process

Applying for a personal loan can be lengthy, depending on the amount you are applying for and the financial institution. Some financial institutions allow you to start and finish the process online, which is very convenient.

Here are some things that will be checked and verified:

• You must provide your SSN (social security number), passport, or driver's license to prove who you are and where you live.
• Credit Worthiness, your credit score will determine how risky you are and the interest rates you would qualify for.
• Affordability, or DTI (debt-to-income) ratio, will be assessed to see how much you can qualify based on your THP (take-home-pay). You need to be able to pay for other obligations even with a new loan installment. You will also need to provide your payslip or other proof of income.
• Bank account information is necessary for loan payout and monthly installment deductions.

Assessment and disbursement times differ from lender to lender, just as the interest rates they will offer you. Personal loans can have rates ranging from 1% to 30%, higher than equity or secured loans.

What to Consider?

• Shop around

Don't settle for the first bank or institution that offers you a loan. Shop for the best interest rate and terms that suit your budget. But be careful when doing this, as too many inquiries can harm your credit score. Some companies can pre-qualify you without making an actual application which would leave a timestamp on your credit record, rather than use pre-qualification to shop around. Remember, the interest rate offered is largely dependent on your credit score.

• Alternatives to a personal loan

Be sure that you consider all the alternatives available to you, such as taking out an equity loan if you have enough equity in your mortgage.

• Is it Necessary?

Personal loans should not be used to buy something you could save up for. Consider if taking out a personal loan for that purchase is necessary.

• Can you afford it

Even though the lender will calculate your affordability, you know your financial situation better. Consider if you can pay back the amount should you have a difficult month or an unexpected expense.

Pro's

• Convenient and fast funding times, some can disburse within minutes and you can do the whole process online or telephonically.
• Offer flexibility in how you use the funds
• No need for collateral
• Lower interest rates when compared to credit cards
• Use it to consolidate existing debt, especially debt with high-interest rates

Con's

• Increased debt load, if you are not careful in managing your debt, a personal loan can be another debt burden to your budget. If you use a personal loan to consolidate existing debt, you must cancel those credit cards and close store accounts.
• The fixed repayment amounts may be an issue for months when you have an unexpected expense. Paying anything less than the required installment will harm your credit score. And unlike credit cards or store accounts, your installment doesn't change as your debt decreases.
• Fees and penalties may be high, especially regarding missed payments. Some lenders charge additional interest on arrears which increases the debt repayment amount.
• Payment fatigue occurs with long-term loans, for example, terms that are 48 months and above. The money is long gone, but you are still paying back the money three years later. This can cause you to default on payments and ultimately affect your creditworthiness.
• Compared to secured debt, such as pension-backed loans, the interest on personal loans can be quite high. In addition, if this loan is a long-term loan (36 months +), the cumulative interest can become ridiculous.

Bottom Line

Banks have strict lending criteria and conduct thorough credit assessments before approving personal loans to safeguard the depositor's money and maintain the banking system's stability. Only those who can reasonably repay the loan are granted access to the depositor's money. As a borrower, it is important to understand the terms and conditions of the loan and to borrow responsibly, as failure to repay the loan can have serious consequences and may negatively impact both the borrower and the depositor's money. Ultimately, personal loans can be useful for achieving financial goals, but using them wisely and cautiously is crucial. The bottom line is that personal loans allow banks to use depositors' money to generate profits. Still, they are responsible for managing the risks involved in lending and protecting their depositors' interests.