Life is filled with unanticipated expenses, and when you least expect it, you could be hit with a financial need that extends beyond your paycheck and your savings.
Each year, tens of millions of Americans facing similar situations turn to personal loans to help ease the financial burden.
With low interest for borrowers with strong credit scores, fixed rates, and a variety of lending sources to choose from, it’s easy to see why personal loans are so enticing.
On the other hand, a personal loan might not always be the best solution to your money problems.
Read on to learn how these loans work and decide whether or not you should apply for a personal loan today.
What Are Personal Loans?
Personal loans are installment loans offered by a bank, credit union, or other financial institution to an individual borrower.
Everything about personal loans is fixed from day one: the length of the loan, the interest rate, and the amount you borrow, meaning the terms of your loan are set in stone.
Personal loans can be either secured or unsecured. The former uses collateral, commonly in the form of your vehicle title, to secure repayment of the loan. The far more appealing choice, the unsecured personal loan, does not require any collateral.
Unsecured loans warrant a much closer look at your credit report and income, though. The better your credit score and debt-to-income ratio are, the higher your chances of approval and access to the best interest rates are.
A personal loan can be as small as a couple thousand dollars to help pay for a wedding to $100,000 for emergency medical expenses.
While terms vary from lender to lender, personal loans are usually repaid over the span of 12 to 84 months.
Reasons to Get a Personal Loan
Whereas other loans like business or student loans are created for a specific use, you can decide how to use a personal loan.
While the reasons to get a personal loan could extend beyond this list, here are a few of the most common reasons people take out personal loans.
Consolidating debt: Personal loans can help with debt consolidation. Consolidating your credit card debt with a personal loan, for instance, can score you a lower interest rate. And faithfully making payments can quickly boost your credit score.
Medical expenses: When health insurance falls short, a personal loan can help you manage the cost of an unexpected medical bill or a pricey procedure. You can also use these loans for vet bills, which could be a literal lifesaver if your furry friend suffers from an unexpected illness or accident.
Life events: When you’re planning a wedding, honeymoon, or comparably expensive milestone moment, you might consider applying for a small personal loan to help foot the bill. Just be sure it’s actually worth the cost and not a frivolous whim.
Home repairs: When your home is in serious need of repair or a costly new appliance, a personal loan could be a viable option for funding updates to your home.
These are just a few popular uses for personal loans. Taking out a loan to fund these types of events may not always be wise, though. Think carefully through the financial repercussions before you do.
How Personal Loans Work
The personal loan process starts with the application, which can be completed online with most lenders.
When you apply for a personal loan, you’ll be asked to provide the lender with information on your financial status to help them determine how creditworthy you are.
The lender will then run a credit check and probably require you to submit proof of income in the form of your pay stubs or tax returns.
When you submit your application, you and the lender will also agree upon the terms of the loan, including the amount of money you will be borrowing and the length of the loan.
With some lenders, you could get approved and receive the money in as little as one day; however, other lenders might take over a week.
Personal Loan Rates and Fees
The interest rate on your loan will be determined by a number of factors. Lenders will look at your credit report and income to assess your ability to repay your loan.
If you have a good credit score, you can expect to find low interest rates. Conversely, if you have a poor credit score and manage to get approved, you’ll have significantly higher interest rates.
A cosigner can help you get lower rates, but the best way to get excellent rates is to improve your credit score before applying for a loan.
Interest isn’t the only cost you need to be aware of with personal loans. When you apply for personal loans, you also need to be on the lookout for fees.
A lot of personal loans come with origination fees, which take out a small percentage or flat amount from the grand total of the loan, often 1% to cover processing expenses. Before locking into a personal loan, read the fine print and make sure to factor in this fee if it applies.
The other fee you should look out for is a prepayment fee, which penalizes you for paying off your loan early.
Numbers of lenders don’t charge a prepayment penalty, so you should have no trouble finding a fee-free option with a little research.
Where to Shop for Personal Loans
The key to getting a great personal loan with low rates is to shop around.
Instead of accepting the first personal loan you get approved for, you should carefully compare all of your options, weighing the pros and cons of each.
You can take the traditional route, checking with banks and credit unions to see what they have to offer. But you can also opt to apply for funding with an online platform that specializes in loans.
To get started, use a service like Lending Tree to get access to several personal loans you’re eligible for, without the negative effects of a hard credit check. Lending Club can give you an idea of the rates you can get from top lenders, making comparison shopping a breeze.
From there, you can apply for the loan of your choice. If you decide to branch out and seek out lenders individually, just make sure you do your homework and partner with a credible BBB-accredited company.
How a Personal Loan Affects Your Credit Score
While comparing quotes online won’t necessarily damage your credit score, applying for a personal loan will. When you submit your application, the lender will run a hard credit inquiry.
So how much does a hard inquiry hurt your score? A hard credit check lowers your score by a few points, and you can expect it to remain on your report for two years.
As you do your preliminary rate shopping, look for lenders who do soft credit checks so your scores aren’t impacted until you’re ready to apply.
Once you have a personal loan, the way you handle payments will play a major role in your credit report.
To maximize the positive impact on your credit score, keep the balance you owe low, pay at least the minimum, and do whatever it takes to make your payments on time.
Alternatives to Personal Loans
Depending on your credit and other financial factors, a personal loan could be the most advantageous lending source.
However, there are times when you could benefit more from borrowing elsewhere.
Here are a couple of alternatives and scenarios where they might make more sense than a personal loan.
- Balance transfer credit card: If you’re facing steep interest rates and looking to consolidate your credit card debt, you might want to look into this type of card. This option is more beneficial than a personal loan if you have good enough credit to get a 0% introductory APR. If you can pay off your credit card debt during that period, you’ll save money going this route. If not, you could accrue tens of thousands of dollars in interest as the rates escalate over time.
- HELOC: A home equity line of credit has a lot of advantages, like competitive interest rates, low closing costs, and flexible terms. This type of revolving credit is valuable, but it does require you to put your home up as collateral, something to keep in mind as you decide how much to borrow. HELOCs come with far longer loan lengths, but the turnaround time for getting funds is quicker with personal loans.
- Personal line of credit: Unsecured personal lines of credit function a lot like credit cards. This source of credit can be beneficial to self-employed individuals whose income fluctuates, as you don’t set a loan amount or repayment schedule upfront. Instead, you can continually borrow without reapplying. A personal line of credit can be difficult to qualify for with a low income or credit score, though, and a lot of lenders charge fees each time you borrow.
Should You Get a Personal Loan?
Depending on your circumstances, a personal loan could be a good option when you find yourself in need of additional funds, especially if you partner with a reputable lender offering competitive rates.
But like any other type of loan or line of credit, a personal loan comes with its fair share of pros and cons.
Before you take on a personal loan or any other form of debt, consider the consequences it will have on your credit and your financial standing.
Make sure you get a loan with payments and terms you can feasibly manage a few months, or years, down the line.