What you should know about personal loans
What is a personal loan?
A personal loan is a form of credit typically used for a specific purpose, such as purchasing a vehicle, financing a holiday, consolidating debt, or renovating a home.
You borrow a specific amount and make regular repayments to your lender. By the end of your loan term (usually between one and seven years), your loan is fully repaid.
A personal loan is a less flexible form of credit than a credit card and typically does not offer additional benefits such as warranties and purchase protection, rewards, travel benefits etc.
However, the interest rate charged is usually lower than that of a credit card and is often negotiable with your lender. Personal loans also have a repayment schedule, meaning you will eventually repay your loan in full and you can easily factor your repayments into your budget.
Before you apply for a personal loan, make sure you are loan ready. Check your credit score and credit report to assess your credit worthiness. Ensure there are no errors in your credit file that could prevent your application from being approved.
Also, read your entire contract carefully so you are not caught out by unexpected interest rates, fees, or fine print.
Variable personal loan
A variable personal loan charges an interest rate that is subject to change. As such, your repayments may vary during the life of your loan.
Many variable personal loans allow you to make extra repayments towards your loan in order to repay it early. Some also allow you to access these funds via a redraw facility and use them for other purposes.
Fixed personal loan
A fixed personal loan charges a fixed interest rate, therefore, your repayments will not change for the entire term of the loan.
Fixed personal loans offer stability. You know exactly how much your repayments are each month and can take this into account when budgeting.
Most fixed personal loans do not allow you to make extra repayments towards your loan in order to repay it early. Those that do, typically charge additional fees that may outweigh the benefit of early repayment.
Secured personal loan
Secured personal loans require you to put up an asset as security. Your security may be a car, boat, jewellery, art, business equipment etc.
If you default on your repayments and fail to make appropriate arrangements with your lender to repay your loan, they have the legal right to take possession of the security and sell it in order to recover their money. This makes a secured personal loan less risky than an unsecured personal loan, so they generally charge lower interest rates.
Unsecured personal loan
Unsecured personal loans do not require you to put up an asset as security. This makes them more risky, so they attract a high interest rate.
If you fail to make your repayments, your lender can take legal action against you to recover their money.
With no security attached, you need to convince your lender that you are able to repay your loan. To better your chances of being approved, some lenders allow you to appoint a guarantor who offers up security that the lender can claim possession of if you fail to repay your loan.
Debt consolidation loan
A debt consolidation loan combines various different loans you may have into one. For example, you may have two personal loans and an outstanding balance on a credit card, each with a different lender. Debt consolidation loans can enable you to consolidate all three into one manageable and potentially more affordable loan.
Consolidating your debts into one loan with a lower interest rate can help you save in interest, fees and charges. It is also much easier to manage, saving you time and limiting the risk that you make a late repayment or forget to make a repayment.
An overdraft is a loan attached to a bank account, giving you access to additional funds, up to an approved limit. By linking the overdraft to your bank account, you have easy access to these funds via online banking and ATM withdrawals.
An overdraft does not have a set repayment term and you will only be charged interest on the credit that you use. In addition to interest, many lenders also charge you an establishment fee and/or a service fee to maintain the overdraft account.
It is easy to overspend when you have an overdraft, so only apply for one if you need it and choose a credit limit that you can afford to pay back.
Loan approval fee
Once your loan has been approved, your lender may charge you a one-off loan approval fee. It covers the cost to the lender to arrange and administer your loan and it is usually added to your loan balance.
Ongoing fees, or service or administration fees, are charged on a regular basis (e.g. monthly, quarterly, yearly) throughout the term of your loan. It covers the cost of maintaining your loan.
Early exit fees
If you have a fixed rate loan and make extra repayments or repay your loan in full before the end of the loan term, your lender may charge you an early repayment fee.
Similarly, if you have a variable rate loan and you repay your loan in full within a specified period of time (e.g. in the first year of your loan term), your lender may charge you a deferred establishment fee.
Interest rates & risk based pricing
Many personal loan providers use so called risk based pricing, which basically means that the riskier they think you are, the higher the interest rate you are paying for your loan.
It should be noted that when you see an advertised rate from such providers, this is the generally the rate for their best customers.
Note that if it’s advertised as rates ‘from x% p.a.’, this may not be the rate you might actually end up paying. So it is always good to know where you stand before you apply and make sure you are loan ready.
Applying for a loan
Many banks and providers these days are able to approve a loan pretty much on the spot and make the money available to you on the same day. Generally you’ll find that if you have a pre-existing relationship with a particular bank, that bank might be more inclined to approve you quickly without too much paperwork.
When you check out the different loans available make sure you take into account any additional charges like set-up/application fee and ongoing fees, which may make a big difference in the effective interest rate you are paying. A good indicator for this is the comparison rate.