Property - 15 Jun, 2020

Advantages and Disadvantages of Personal Loans

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There are so many types of loans out there and sometimes, you need a helping hand to get you through to the next stage of your life. Whether it be a wedding, a new car or remodelling your home, a personal loan can get you to that next stage faster.

Australia’s personal loan market is very competitive, with dozens of lenders offering about 200 different loan products. Like all financial products, personal loans come with both advantages and disadvantages. Taking out a personal loan is a big step and you want to make sure you have decided which loan is best for you and what the advantages and disadvantages are.

Related: How personal loan debts are jeopardising first home buyers

What is a Personal Loan?

A personal loan is a type of loan you take out for the purpose of yourself and it is a lump sum payment of between several hundred dollars, to $100,000. It is a similar process to credit cards, but the difference is -personal loans tend to be much cheaper. This type of loan works by you borrowing a specific amount of money from a financial institution and then repaying this amount, including interest, over a set amount of time based upon an agreement set by you and the lender.

<img src="woman-taking-out-personal-loan.jpg" alt="woman sitting at desk with broker discussing personal loan">

Different Types of Personal Loans

There are two types of personal loans;

  1. Secured loan
  2. Unsecured loan

Secured Loan

A secured loan is a personal loan that requires you to offer something up as security in the event that you are unable to pay your repayments. Individuals will often receive a lower interest rate as there is less of a financial risk with repayments. Usually with this loan, people use something they own as security, their house, their car or another big-ticket item, and the lender knows that if the individual fails to meet the repayments, they are entitled to the assets and can take them to court.

Unsecured Loan

An unsecured loan is the opposite, this personal loan is where the lender requires no security on the debt. This means your loan isn’t backed up by any personal collateral. The interest on this type of loan is higher as the lender has no security that they will get the money back from you. Unsecured loans are a more flexible option for borrowers, but if the repayments aren’t made the lender can take you to court.

Secured vs. Unsecured Loans

There are three primary differences between these two personal loan types which are:

1.Asset Requirement

The main difference between these two loans is the security you provide against your agreed loan. Secured loans are backed up by an asset you own, which makes the loan a less financial risk for the lender, opposed to the unsecured loan where there is no security asset.

2. Variances in Interest Rates

Due to the security asset making secured loans less of a financial risk, they will have a lower interest rate in comparison to unsecured loans. As there is no security asset, financial institutions have a higher interest rate with unsecured loans.

3.Restrictions on Loan Usage

Unsecured loans are more flexible than secured loans, they allow you to use the funds for whatever purpose you intend. A secured loan, however, may impose tighter restrictions where the lender may require the borrower to use the total loan amount to pay for the specific reason the loan was taken out.

Advantages of a Personal Loan

It is versatile and flexible

unlike other types of loans, personal loans can be far more flexible in relation to what you put the money towards. They offer different types of personal loans which can save you money on interest repayments. Once approved, you have access to the lump sum of money within a few days depending on your lender.

Competitive interest rates

as mentioned before, some personal loans offer a lower interest rate than credit cards, potentially saving more on interest. The average interest rate of personal loans is often about 5% lower than the average credit card interest rate.

You don’t need great credit

unlike other larger loans that are based largely on your credit scores, personal loans are possible with bad credit. The lender will end up instilling higher rates though.

Related: How to protect your credit score during the coronavirus shutdown

<img src="credit-score-report-personal-loans.jpg" alt="credit score report on desk for personal loan">

Borrow what you need

Maybe you need to renovate your house or need to buy a car. A personal loan is an easy way to help you purchase a big-ticket item now and then pay it off later. You can borrow the amount of money to cover this and repay it back over time.

Quick to access

Personal loans are often smaller than other loans that are on offer, and this is why they can often be approved a lot quicker than other loans. Whether you have an unexpected emergency to your home or unprecedented medical expenses – a personal loan is a great way to receive a large amount of money fast.

Consolidate existing debt

Debt can accumulate much quicker than people think, and as the bills pile up so does your stress. Many people take out a personal loan due to the flexibility and potential lower interest rates, to pay off any existing debt. Usually, people will use personal loans to pay off their credit card bills, and the lower interest will save you in the longer run.

Related: Refinancing to consolidate your Debt

Disadvantages of a Personal Loan

Higher interest rates

Just because they have lower interest rates than a credit card, it doesn’t mean the rates aren’t still high. If you are on a variable-rate personal loan, the interest rates can fluctuate at the lender’s discretion, which can cause your monthly repayment amount to increase or decrease.

The application process

Personal loans can often be lot quicker to apply for than credit loans for example, however they still require a formal loan application process which can be time-consuming if you don’t have the requirement documents. Sometimes, borrowing money through a credit card is much cheaper and if you borrow money through your credit card, you could also repay the debt in full during your interest-free period.

Related: What you’ll need when applying for a home loan

No part payments

If you ultimately decide that you want to pay off the personal loan immediately, you will typically have to pay a break fee. These fees can be very expensive as the banks and financial institutions need to make up for the lost interest and fees, they would have accumulated from you over the life of the loan.

Locked in contract

Your payments are made monthly or weekly, however you and the lender have agreed upon. They are fixed in this contract with a certain amount to pay off, while credit cards give you extra time to pay off the balance, if you miss a loan repayment the lender can take you to court which could add into additional fees.

<img src="signing-loan-contract" alt="man signing contract for his personal loan">

Origination fees

Many personal loans come with an ‘origination fee’, which covers the cost of processing the loan and amounts to about 1-6% of what is being borrowed. It just sounds like additional fees that could be avoided.

Debt cycling

A personal loan is an option if you need to consolidate debt, however it is not a permanent fix. All you’ve done is debt cycled and transferred your debt from one, or multiple sources to your personal loan which you will still be paying interest for.

Related: Refinancing your home loan to consolidate your debt

When and if you are applying for a personal loan, it is important to weigh up the interest costs of all types of personal loans and decide what works for your circumstances. The answer to taking out a personal loan isn’t black and white.

It is best to consider both advantages and disadvantages of the personal loan you are going to take out and research the comparison interest rates. By weighing up the pros and cons you are able to work out what is best for you and what you need.

Personal loans can be extremely helpful when you need them, just make you sure weigh up every available option and always consult a financial expert or speak to your lender, before making a decision.

Words by Ece Demir

Are you on the lookout for the best personal loan? Contact eChoice to help you work out your options. With access to 100s of mortgage products from over 25 lenders, eChoice has the resources to get you the best deal.

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