A personal loan is a type of credit that can help you consolidate high-interest debts or make a big purchase. Before you decide to apply for a personal loan, it is important to understand the basics.
When you apply for a personal loan, you essentially borrow a fixed amount of money from a credit union, bank, or lending institution. While you get an auto loan to finance your car and funds from a mortgage are used to pay for a house, a personal loan can be used for many different things.
You can use it to consolidate debt, purchase a new furnace, appliance, or a major household purchase, or help pay medical or education expenses. Here are some common loan terms you should know before you apply for a personal loan:
Principal: This is the fixed amount that is borrowed. For instance, if you apply for a $10,000 personal loan, the principal amount is $10,000. The lender calculates the interest that they will charge you based on the principal amount that you owe. The principal amount decreases as you continue to repay your loan.
Interest: When you take a personal loan, you agree to clear your debt with interest, which essentially is the lender’s “charge” for letting you borrow their money, use it, and repay it over time. In addition to the portion of your payment that goes towards reducing the principal amount, you’ll also need to pay a monthly interest charge. The interest is generally expressed as a percentage.
APR (annual percentage rate): In addition to the interest, when you get any kind of loan, the lender will also charge you a fee for making the loan. APR includes both your lender fees and interest rate, to give you a clearer picture of the actual cost of your personal loan. To compare the value and affordability of various personal loans, it is advised to compare APRs.