What is a personal loan?

Co-author: William Jolly 

Are you thinking about buying a car, starting renovations on your house or consolidating your debts into one repayment? A personal loan could help.

We’ve broken down the basics of personal loans, so that you’ll be able to make the best choice for your situation.

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What is a personal loan?

Personal loans are fairly straightforward financial products. A personal loan allows you to borrow a specific amount of money, usually from a financial institution, and then repay the debt with interest in equal payments over an agreed term.

Personal loans offer the general advantages of being cheaper than the closest alternative (credit cards) as well as giving the discipline of a repayment schedule.

Many personal loans allow the borrower to make extra repayments. Every dollar you repay above the required repayment shortens the life of the loan as well as the overall cost.

There are two different types of personal loans that can be taken out. They can either be secured or unsecured.

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Types of personal loans: secured vs unsecured

Secured personal loans

Secured loans use an asset to secure the loan, such as a car. This asset is then used as a kind of security against the debt. The money borrowed can generally bs used for any legal purposes, such as debt consolidation, home renovations, school fees, paying for a holiday or buying a car – although check with the lender first! If you are unable to repay the loan, the lender may be able to sell your security item.

Unsecured personal loans

Unsecured loans are so-called because the lender requires no security for the debt. The loan is still subject to your ability to repay it, and if you aren’t able to do so, the lender may take you to court. The interest rates on unsecured loans are higher on average than secured personal loans, which reflects the higher risk of losing money for the lender.

Personal Loan Hints and Tips

When applying for a personal loan, be it secured or unsecured, you should always check the following information with your lender.

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Questions to ask your personal loan lender

There are no doubt plenty of other questions you will want to ask your prospective lender, but here are some to start you off.

What is the personal loan interest rate?

At the time of writing (21/03/2019), personal loan interest rates in Canstar’s database range from 6.99% to 26.99% for an unsecured personal loan and 6.99% to 21.60% for a secured personal loan.

How can I qualify for a lower personal loan rate?

The interest rate that you are charged will depend in part on your credit rating.  If your credit rating score is too low, you may find that the lender declines your loan application. To help prevent this from happening, you should obtain a copy of your credit file and check to ensure there are no nasty surprises.

Are there any application or ongoing fees for this personal loan?

Many personal loans have both an application fee and an ongoing fee. Some may also charge you an early repayment fee. Canstar’s database shows that personal loan application fees range between $200 to $250 for a secured personal loan and $50 to $450 for an unsecured personal loan, based on borrowing $15,000 for a term of 5 years.

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Is the personal loan interest rate fixed or floating?

A fixed rate personal loan means that the interest rate is fixed for the life of the loan.  A floating rate means that the interest rate on your personal loan may change at any point in time.

Choosing to fix your interest rate, or take your chances with a variable one is, once again, entirely personal. Fixing your interest rate gives you the certainty that your repayments will stay the same for the term of your loan. It’s a buffer against rates going up and hence increasing your repayment amount. A rate increase may cause a problem if you are on a strict budget and only have a set amount to devote to the loan. The downside is, of course, that if rates dive further you may end up paying a higher amount.

You may also choose a floating rate to take advantage of the favourable rate conditions. A floating rate will theoretically move up or down in line with the RBNZ cash rate. The tables below show the spread between minimum and maximum rates on our database (as of March 2019), as well as the difference between floating and fixed interest rates:

Floating
  Min Max
Unsecured Personal Loan 6.99% 19.99%
Secured Personal Loan 6.99% 6.99%
Fixed
Unsecured Personal Loan 6.99% 26.99%
Secured Personal Loan 8.90% 21.90%

Source: Canstar personal loan comparison tables, March 2019. Based on a loan amount of $15,000 over 5 years.

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Can I make extra repayments or lump sum repayments to the personal loan?

Most lenders will allow you to make extra repayments, but it’s certainly worth asking the question.

Is there a penalty for paying off the personal loan early?

If you manage to pay off your personal loan early, you may come across an early repayment fee. It’s certainly worth checking this with your lender, and making sure the early repayment cost doesn’t outweigh what you’ve saved by shortening the length of your loan.

How can I check how much I have owing?

This is generally pretty easy – most financial institutions have good online banking services.

How can I make my repayments?

Generally, repayments will be set up as an automatic direct debit from a nominated bank account. Just ensure that you have enough money in there each month to cover the cost!

What other fees are there attached to my loan?

Does the lender charge a monthly account-keeping fee or administration fee? What about a late repayment fee, or an early discharge fee? Make sure you get a full list of fees and charges that could potentially be charged to your loan account.

And, of course, shop around! There are plenty of personal loans available, so don’t settle for something that’s not quite right.

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