A personal loan differs from other forms of lending products because it is not backed by a security, and yet is still designed to reduce the risk for the lender. It differs from other forms of structured loans because the lender does not have the ability to recover its money by selling a specific asset. Because it is not tied to a house or a car, interest rates must necessarily be higher for a personal loan.
A personal loan also differs from a credit card. Although credit cards provide a convenient service, they usually carry high interest rates to reflect the risk of letting people buy anything at any time. Consumer purchases cannot always be reclaimed, and small debts are not worth collecting. Credit cards also entice buyers with gimmicks and have penalty APRs. It is not advisable to use a credit card except as a last resort.
Personal loans are provided by banks and other structured lenders. One type of personal loan that might be offered by a bank to its customers is a line of credit. These are similar to credit cards, but the interest is much lower because it is tied to a bank account. There may be fewer frills, but lines of credit can be very useful to obtain mid-term credit.
The best interest rates usually come from negotiating with a bank representative or other structured lender for a loan. A fraction of a percentage point might be subtracted for having a checking or savings account with the bank. The interest can also be lower based on the nature of the purchase, the duration of the loan, and a person’s credit rating.
While other lenders do not have the added security of direct access to a customer’s bank account, some of them are able to offer surprisingly low rates. They might be willing to take greater risks in order to compete with banks, but their loans might also have additional stipulations. Thoroughly review the fine print to see if there is any condition where the interest can change or if additional fees apply.
It does pay to shop around, but the first place to look is a reliable bank with an established relationship. Factors such as increases in the federal interest rate also affect the interest on a bank loan, but rates are also lower where any form of security is involved. Banks have greater resources to pursue bad debts and so might have greater security than an independent lender.
Credit rating is not the only way a lender assesses risk, but lenders are obliged to offer similar services to customers in similar circumstances. Credit rating is an important starting point, so the first step to getting the best interest rate is to maintain a good credit rating. Consider pursuing small loans before graduating to large loans.
Whatever route is chosen, a little research can save hundreds of dollars on a personal loan. It is also good to look for ways to reduce the total amount borrowed. A credible lender should be flexible and forthright in addition to offering a good rate upfront.