How Do Loans Work? Borrowing, Interest and Repayment

How Do Loans Work? Borrowing, Interest and Repayment

Americans are feeling pretty good about their finances nowadays. Unemployment rates across the country are at record lows, incomes are steadily increasing and people have a generally optimistic view of the U.S. economy as a whole. These factors help explain why more than 55% of adults describe their financial situation as “good,” or “excellent,” according to a recent Gallup survey.
However, every now and then, people encounter issues or seek to purchase a product or service for which they don’t have all the necessary funds. And in so doing, they consider getting a personal loan.
One thing is certain about loans: Loans work. But have you ever wondered how loans work? That’s what the following will help you get to the bottom of so you can then decide the type of loan that’s best for your family’s finances and spending needs.
What is a loan?
Perhaps the best place to start is with a loans definition. A loan is essentially an agreement, typically between two or more parties, in which a sum of money is borrowed for a particular time period, or what is known as a term. The amount that’s borrowed is then repaid with interest attached. As The Balance noted, a loan ceases to become one if it’s not paid back. That would make it a gift. It’s the repayment element that represents the core component of the loans definition.
How does loan repayment work?
Just as there are many different types of loans – such as unsecured loans, short-term loans, title loans and installment loans – loans can be repaid in a number of ways. Occasionally, they’re paid back all at once in a lump sum by a certain date or before then. Generally speaking, though, they’re paid back over time. Take the aptly described installment loans as a case in point. As its title implies, an installment loan is a financial product that is paid back on a regularly occurring schedule, usually with monthly payments. An auto loan, which is a type of installment loan, enables you to buy a new or used car so the money is put up all at once to the seller. It’s your job to repay that amount to the lender until the debt is fully paid off. A fixed interest rate is usually attached, although others may include variable rates. The word “fixed” refers to the interest rate, which stays at the same rate for the life of the loan. This provides you – the borrower – with predictability as to how much you’ll spend each month before the loan is paid back in full.
What is a personal loan?
Another type of installment loan is known as a personal loan. Similar to mortgage or auto loans, they’re repaid in installments, but unlike the aforementioned, they can be used for more than one purpose, hence the “personal.” This may include debt consolidation, a home improvement project or some other large purchase.
There are a few other ways that getting a personal loan differs from other types of installment loans. Personal loans are generally unsecured loans. This means you don’t need to come up with collateral as a precondition for approval. For mortgage loans, the collateral would be the house; the car would be for auto loans. This creates added risk for the lender, so the interest rate on a personal loan might be a bit higher compared to a secured loan or there may be an origination fee attached, which covers the cost of processing.

Are personal loans bad?
Because of the potentially higher interest rate and the origination fee – which typically ranges from 1% to 8%, according to NerdWallet – some argue that personal loans should be avoided altogether. Nothing could be further from the truth. Many lenders offer competitive interest rates. By comparing them and understanding the terms and conditions that may apply, a personal loan can be the ideal financing solution for your spending needs. Your lender is required – by law – to disclose items like the interest rate, origination fee and all other fees.
How does the personal loan approval process work?
Now that you know a little more about how loans work and the some of the characteristics of personal loans, you may be wondering how to get a personal loan from the many online lenders that are out there.
Just as you, the borrower, want to be sure that your lender has the money you need for an expense, the lender needs certain assurances as well, namely that you’ll be able to pay back what you borrow. To do that, they may ask you for various pieces of personal information that can corroborate that you have adequate income and pay your bills on time. Here are a few personal loan items that may be needed to consider you for approval:

  • Copy of your credit report
  • Statement of available funds
  • Proof of stable income
  • Document stating your salary
  • Recent payments history

Many of these same items are required to get a loan from a bank. Your credit score is basically the numerical representation of how effective you are at managing money. The higher the score, the more likely it is that you’ll be approved. A high credit score can also make a difference in your interest rate, enabling you to potentially borrow at a lower rate of interest compared to other borrowers whose scores may be less than sterling. If you’re looking to improve your credit score, you can do it by making sure to pay your bills by their due date and by keeping your balances low, along with other smart tips suggested by the credit bureau, Experian.

What are the minimum and maximum loan terms?
As previously referenced, “term” often refers to the amount of time you have to pay off a bill, such as 30 years for a mortgage loan or five years for an auto loan. But the word in this context is more related to how much you’re authorized to borrow. For Omni military loans, as an example, you may be eligible to borrow as much $10,000 or as little as $500. The amount may depend on your financial situation and, the conditions established by your lender.
You have a lot of options when it comes to borrowing money, but if you’re in the active duty military or are career retired, consider Omni Financial your best bet. We’re not only a leader in military lending but are here to serve you anyway we can, both as an advocate and as a resource. Plus, all of our loans are 100% guaranteed. Please contact us to learn more, or apply for a loan now.
The information provided in this blog post is for informational purposes only. It should not be considered legal or financial advice. You should consult with a financial professional to determine what may be best for your individual needs.  Omni Financial does not endorse, recommend or imply affiliation with the referenced companies or organizations.

Friendship Rewards Program
Refer a friend and get a $25 Omni Gift Card