January 14, 2007, 11:00 am

The Personal Loan

by: admin    Category: Types of Financial Products
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Years after years, banks, insurance companies, investment companies and other financial institutions create new financial products. In the following articles, we will review many different ways of getting credit from one of those lenders. We will start this series of articles with the personal loan. We will then cover it characteristics along with the factors that could increase your chance of approval.

Definition

By definition, a personal loan is an amount of money borrowed at a prescribed rate on a predetermined lapse of time, also know as amortization. During this period of time, the borrower must make payments. Those are equally divided along the term of the loan. An individual might repay his loan on a weekly, bi-weekly or monthly basis.

The rate can be variable or fixed. The variable rate is usually lower because it fluctuates with the Prime Rate. The Prime Rate is set by the financial institution according to the Government’s overnight rate. The overnight rate is the interest rate at which major financial institutions borrow and lend one-day (or “overnight”) funds among themselves. Fixed rate guarantees the same interest rate and the same payment for the whole life of the loan. It reduces the risk for the borrower but determined the revenue for the lender. This is why fixed rates are higher; a premium must be paid to the institution to compensate potential gain for a variable rate increase. If you do not have a tight budget, I definitely suggest you take a variable rate.

On top of your regular payment, you can also apply a lump-sum payment on your loan. Most institutions won’t charge a penalty fees like it would be the case for mortgages. Therefore, you always have the option of paying partially or totally your personal loan at anytime. On the other hand, many banks will require a whole new application if you want to recalculate the payment after reducing the balance of your loan by a significant amount. They call this process a renegotiation. All those terms must be validated before signing the loan contract.

Needs

Personal loans are mostly used when an individual requires a sum of money at a specific time. The need is then known and the amount as well. An individual might need money to buy a car, a boat, furniture or to buy a land. The personal loan is a good product when the amount required will not fluctuate over time and the personal is able to make fixed payment.

Qualification

When your application gets to the credit underwriter, some factors might influence his decision. The most important point of analysis will be your Credit Bureau. As previously mentioned in other articles, the Credit Bureau is a summary of your credit behaviours. Therefore, your Beacon Score is related to your credit worthiness. If you pay your debts on time and you don’t keep your credit cards to the top, you have good chances to qualify for a personal loan.

Another point will be your Total Debt Servicing Ration (TDSR). In order to calculate this ratio, you must add up your monthly payment (all personal loans payments plus 3% to 5% of the balance of your credit cards and lines of credit) and divide it by your monthly income (without child support or other government allocations). Financial institution will consider your application if your debt ratio is below 40%.

Some lender might also look at your net worth if the amount of the loan is substantial. Lending $35,000 when your net worth is at $25,000 might be risky for the bank. In these cases they might ask for collateral or a co-applicant. We will with about those two topics in the futures.

Negotiation

There are few points for negotiation with a personal loan. The rate is usually determined by your credit rating and the amount itself. You might be able to negotiate a reduction if you have an above average credit rating or if you already have several products with the same institution. A good repayment history with the same branch could be a good point of negotiation. You can always shop around to see what other banks will give you. Most personal loans have a maximum amortization of five years. This can also be negotiated with your banker with strong arguments (high net worth, repayment capacity, credit history…).

In conclusion, please remember that your whole application will be verified (from your employment to your Credit Bureau). It is useless to not disclose relevant information as everything will be validated. The personal loan is a useful tool to provide a fixed amount of money that you can repay overt the next five years.

By definition, a personal loan is an amount of money borrowed at a prescribed rate on a predetermined lapse of time, also know as amortization

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