How do personal loans work?

A personal loan can be a great boost when you are facing a financial hitch. It is, however, crucial to take time to confirm that it is right for you before signing off on it.

The key to knowing if a personal loan is ideal for you is understanding how it works. Grasping the inner workings of a personal loan will help you get the best deal and save you some money in interest and fees.

How do personal loans work?

Personal loans work pretty much the same way as other loans i.e. you receive a specific amount from the lender and agree on the repayment terms. There are a couple of steps involved in securing a personal loan, such as assessment, approval, and repayment. Note that the amount you pay back depends on the principal, other lender fees, and the interest charged.

Do all personal loans have the same interest rate structure?

No. Some lenders set different interest rate structures on their personal loan offerings. Based on this, personal loans can be grouped as fixed or variable.

Fixed interest rate loans: These carry the same interest rate for the entire length of the loan. Here, you pay the same amount of interest throughout the repayment period regardless of the changes in the interest rate. While it is an exciting option (makes budgeting easier), it can make you miss out on savings if the lender lowers the variable rate.

Variable interest rate loans: For personal loans with variable interest rates, the amount of interest paid can change at any time. Their main upside is that you can benefit in terms of savings if the interest rate is reduced. On the downside, you'll be paying more if the lender increases the rates.

What are the types of personal loans offered in Australia?

There are different types of personal loans offered by Australian lenders. The popular ones are:

Unsecured personal loans These loans are the exact opposite of secure loans and don't require you to attach an asset as security. They are risky for the lender and have a higher interest rate. They also have no limitation in terms of how and where you can spend the funds borrowed.

Secured personal loans: For secured loans, you need to attach an asset of equivalent value as collateral. The commonly accepted assets include vehicles and home equity. Note that for these loans, you don't have to use the loan funds to purchase any specific assets. They are less risky to the lender, and as such, they have lower rates.

Car loans: Car loans are meant to facilitate the purchase of a vehicle, either new or used. The vehicle purchased acts as a security for the loan and can be sold to settle the loan in the event you default. Some lenders set restrictions on the age and condition of the car, which is why you need to confirm the terms.

Cash advance loans: Cash advance loans are generally smaller loaners that have a shorter loan term and very high interest rates.

What can I use a personal loan for?

Personal loans can be used to sort out different needs depending on your financial situation. Most Australians borrow personal loans to consolidate debts, pay for weddings/holidays, renovate homes, and even pay tuition fees.

How do I compare & choose the right personal loan?

There are different ways of comparing personal loans in Australia. You can choose to speak to a financial advisor specialising in loans, use comparison tables or calculators.

Financial advisor. A financial advisor will direct you on the best approach of taking a loan based on your financial situation.

Comparison tables.These help you identify and draw a direct comparison of different loan options and their respective terms.

Calculators.These allow you to work out how much you can borrow and what it will cost to repay each loan. It is advisable to use comparison tables to narrow down your options and then use the calculator to find the most affordable and convenient loan option for you.

Pros and Cons of personal loans

Here are the benefits and drawbacks of personal loans

Pros Cons

They can come in handy when you need to get your hand on extra cash in a short time

The application process can take a while compared to when borrowing funds through a credit card

On average, they have lower interest rates than credit cards

Some lenders charge high interest rates and additional costs

They come with a structured repayment plan that allows you to plan your budget easily

They are legally binding and thus impose financial commitment

 

The personal loan application process

Comparing your options

This is the first step when you’re looking to secure a personal loan. Some of the important things to consider when comparing different loan products are:

  • The loan amount
  • The interest rate as well as other fees charged e.g. starting, late payment, redraw, account keeping, early exit, and administrative
  • The terms of the loan
  • The repayment period granted for the loan you’re borrowing

Loan Qualification

The eligibility criteria for personal loans varies depending on the lender, but the most common qualification terms are:

  • Be at least 18 years old
  • Be an Australian citizen or a permanent resident
  • Have regular income usually above $35,000. Centrelink benefits may count as income to some lenders
  • Have a good credit history

Be sure to check with your lender what the eligibility criterion is before applying for a personal loan.

Note that being eligible for the loan doesn’t necessarily guarantee that your loan application will be approved. Your application could still get rejected based on previous debts or the stability of your employment.

Loan Application

The process of loan application also differs from one lender to another. Today, most lenders have an online application process, but some may still require you to visit their branches.

Some of the information & documentation that lenders ask borrowers to provide include:

  • A driver’s license, passport, or ID
  • A copy of your bank statement
  • Income receipts if you earn Centrelink benefits
  • Tax returns if you are self-employed

The application process usually takes a short time between 10 and 20 minutes.

Loan Approval & Repayment

Approval can be instant or take up to a week depending on your lender. You can get full approval or conditional approval. The latter takes less time but often requires you to provide additional information.

Once the lender has fully approved your application, the funds are directed to you depending on the type of loan. If it is a car loan, for instance, the lender can wire the funds to you or pay the car dealer directly. If you're taking a loan to consolidate your debts, the lender can directly pay your debtor.

You’ll then be required to start repaying the loan in instalments based on the repayment terms agreed. Some lenders have restrictions or penalties for both early and late repayments.

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