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Personal Loan Terms: What You Need to Know
Personal loans are a popular borrowing option, and many people would like to know more about them. Don't worry, this article won't be full of confusing financial terminology. Instead, we'll focus on one subject: personal loan terms, meaning how long a period money is borrowed.
Loan terms affect many other parts of a loan, such as monthly payments and the total loan amount that must be repaid. It's one of the key factors you must look at when you consider a personal loan.
What is the normal term for a personal loan?
Most personal loan lenders offer a range of terms. At TD Bank, for instance, loan terms range from 36 to 60 months. You can find other lenders who will offer a loan term as short as 12 months and as long as 84 months (7 years.) These extended-time loans are sometimes referred to as "long-term loans," but that's an informal label. They tend to function the same as any other personal loan.
Let's explore the factors of a typical personal loan:
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Many personal loans are unsecured loans (as opposed to secured loans, where collateral is required.)
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The interest rate is fixed over the length of the loan, no matter how national interest rates change.
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They are offered by a variety of lenders, such as credit unions, banks and online lenders.
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Personal loans tend to be used for home improvements, debt consolidation, vacations, weddings and large purchases. As an example, TD Bank offers personal loans in amounts ranging from $2,000 to a maximum loan amount of $50,000. That covers a lot of ground, from a bit of credit card debt up to major home renovations.
How are personal loan terms calculated?
When making loan decisions, borrowers might be focusing on how much their monthly payment will be. But there's more to the loan than just loan payment amounts. Here are some aspects of personal loan repayment terms.
Interest rate
Lenders base the interest rates for personal loans on several factors. A major influence is your credit score. Those with a less favorable record or no credit history will generally have a lower credit score. This usually results in a higher interest rate being offered for a loan. Borrowers with high credit scores may receive lower interest rate offers. That's why excellent credit (or, at least, good credit) can save you money in the long run.
In a sort of push-pull relationship, loan length also influences loan interest rates. Shorter loans tend to get lower rates—often, the longer the personal loan term, the higher the expected interest rate. That's because shorter loans present less risk to lenders, as there's less time for a borrower's financial situation to change for the worse.
Amount of interest paid
The next consideration is this: how much is the loan going to cost you? The longer the repayment terms, the higher the interest rate. And a higher rate, plus paying that rate for more months, means more overall interest charges paid. Because the extra is spread out over the loan, it might not seem like a big deal. And you might either enjoy or need the lower monthly loan payments that come with a longer loan term. But if that money stayed in your pocket instead, you might be able to enjoy it even more.
Monthly payment
As we said, it can feel good to have lower monthly payments. But for every extra month you tack onto your loan, there's less money in your hand at the end. The following scenarios show how rates and terms affect the overall cost.
What loan term is best for me?
If you're thinking about taking out an unsecured personal loan, here are some factors to consider before deciding on the loan's term.
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How big a monthly payment can you afford? Make sure there's enough in your bank account at the end of the month to make loan payments and still live comfortably.
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How much do you need to borrow? Don't overdo it. Request what you really need to reach your goals. The more principal borrowed means bigger payments and more interest charged.
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Does the lender offer important perks or benefits? Do they offer fast loan approval? Quick payment of funds? If you're using the loan to consolidate debt, will the lender directly pay your creditors on your behalf?
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How stable do your finances appear to be? If you expect your financial situation to change, or if you aren't sure about your future work status, taking out a long-term loan might not be a good idea.
What else should I consider?
There's more? Yes. There are a few more factors to think about, and they're important ones.
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Credit score. To start with, get a copy of your credit report and look it over for inaccuracies. Credit approval, interest rate offered, and the maximum loan amount available are all influenced by a borrower's credit score range.
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Debt-to-income ratio. Also known as DTI, this ratio reflects how much you currently owe each month, in relation to what you earn. It includes rent or mortgage, credit cards, and any other loans or payments. Lenders typically look at DTI, along with credit score, to calculate the odds that you'll be able to afford another monthly payment. Optimally, it's best for your DTI to be quite low. Above a certain percentage might concern lenders, and they might therefore limit your loan options to reduce their perceived risk
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Fees. Some lenders charge an application fee, an origination fee, or both. An application fee is a set price you pay, usually in advance and nonrefundable, charged for a loan application. An origination fee is different. This is an extra percentage a lender may charge if your loan is approved. The fee is subtracted from your proceeds and you receive a smaller sum, or the fee is added to your principal and you pay interest on the extra charge.
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Auto-pay. Some lenders will let you set up automatic payments, drafted monthly from your checking or savings account. In return, the lender may offer a small discount on the loan. This allows you to save money, and you won't miss a payment—as long as your bank account consistently contains enough funds to cover the automatic payments.
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Digital options. If you have a good relationship with your bank's loan officer, have a chat with them about your needs. But you might also consider online applications—they're now fairly easy and can be completed from the comfort of your home. Plus, some online lenders, like TD Bank, may offer same-day approval and next-day funds. And many lenders now offer mobile apps to let you monitor your loan status, check payments and even shift payment dates.