Are you one of the 56% of American consumers who admit they’re living paycheck to paycheck? How much are you able to save from your pay each month? Some 49% of Americans have saved less than $500 in the last three months.
In fact, less than 4 out of every 10 Americans couldn’t pay for an unexpected financial expense costly $1,000.
These stats might be one of the reasons you’re considering a personal loan. Whether you’re strapped for cash or have another need for a personal loan, here’s everything you need to know about getting one.
From your debt to income ratio to finance rates to the pros and cons of personal, read on for everything there is to know and consider about personal loans.
Table of Contents
What Is a Personal Loan?
A personal loan is one type of loan you can get from a bank, credit union, or online lenders. It is different from a mortgage or auto loan, for example, because the money can be used for whatever purpose you choose. Although you should be prepared, your lender of choice to ask why you want or need the loan.
Personal loans are paid out in one lump payment, different from, say a line of credit where you draw from it as needed. They tend to have shorter terms for repayment than other loan types and often a little higher interest rates.
Evaluate Why You Need a Personal Loan
Because the terms of a personal loan can sometimes be unfavorable, you want to really consider why you want to get a personal loan. Do you have an emergency that has to be addressed? Are you hoping to tackle a problem like a home improvement project or pay off a debt? ( More on reasons to get a personal loan later).
Is there another option you might select other than getting a personal loan? If you have bad credit, the terms of a personal loan can be costly, so you should consider it if you have another option.
Consider your timing, too on your personal loan. You might find that you could generate some savings or improve your credit and get better terms on the loan by waiting a period of time.
Good Reasons for Personal Loan
So, what might be a good reason to seek a personal loan once you understand how they work?
If you have decent credit, you might be able to secure a personal loan with terms that make it worthwhile. For example, you might find a personal loan that has a better interest rate than your high-interest credit cards. This would allow you to pay off the credit cards, make one payment to the personal loan and save on interest.
Here are some good reasons to consider a personal loan:
• Credit card refinance
• Debt consolidation
• Home improvement
• Major purchases
• Car financing
• Emergency loan
You always want to consider all your financing options, then choose the one that will save you the most money over time. For example, you might want to buy a car. If you can get a personal loan for a lower interest rate than the dealership is offering, it’s worth it. You might be buying a car from an individual where financing isn’t available.
While personal loans are convenient because you get the money and discretionary how you use it, the terms can vary greatly.
Common Uses for Personal Loans
As you consider your options, there are times when it might make sense for you to use a personal loan. Individual circumstances always vary, especially because of factors like credit score and credit history, where the terms of the loan can be greatly impacted.
Here are some of the most common reasons people seek debt consolidation and whether it might be a smart option for you.
One common reason to seek a personal loan is for debt consolidation. If you have multiple credit cards at higher interest rates, it might make sense to consider this option.
If your personal loan interest rate is even slightly lower than your credit cards, it might make sense to get one larger loan and pay off all the credit card debt. This allows you to make one monthly payment. Often the terms of a personal loan are shorter too, making it so that balance will get paid off.
Two things to consider with this option. First, debt consolidation only works if you no longer use the credit cards you’re paying off.
Depending on your credit score, you might be able to find a low-interest rate card that would allow you to do a balance transfer and be better off than with a personal loan. You also have to remember when considering the personal loan that you will need to factor in interest rate and the application fees and loan origination fee that add to the overall cost of the loan.
Personal loans are also used for home improvement projects under certain circumstances. Maybe you have a small project that you want to finance. A personal loan can get paid off in shorter terms, and the project can get completed.
You might be a relatively new homeowner who hasn’t built up a large amount of equity in your home yet. This means seeking a home equity loan or home equity line of credit isn’t an option for you.
You’ll want to weigh the higher interest rate that likely comes with a personal loan over the time it takes to build some equity for one of the other borrowing options.
Some major purchases just can’t wait. If your refrigerator dies, you can’t live without one. If your water heater goes kaput, you’ll only be able to tolerate those cold showers for so long. Some major purchases take on urgency and can’t be avoided.
You’ll want to weigh the personal loan terms against a store credit card for those kinds of situations.
You might be tempted to make a major purchase using a personal loan because it’s something you want versus need. Maybe you’re pining to buy a boat or new fishing equipment for your boat. Consider whether the interest you’ll pay is worth it over time. You might be smarter to save the amount you’d make in payments and put it towards your purchase while saving interest too.
You could use a personal loan to buy a car. There might be options that are more lucrative for you, like seeking an auto loan instead. You’ll often get a better rate with an auto loan and qualify for a larger amount because the car can become collateral on the loan.
If you find you have an unexpected car repair, you might choose a personal loan. If the repair goes beyond your savings or credit card limit, it would allow you to get the loan paid off over time and get your car running too. This can’t be said enough time though, always shop around and consider the cost of the loan based on the interest rate, loan-application fee, and loan origination fee.
Small Business Financing
If you’re a small business owner, you know there are plenty of times when money is tight, or you’re experiencing a cash flow issue. Maybe you need to spend some money on your business so your business can grow and produce more income.
Though, for many small businesses, they either haven’t been in business long enough or don’t have a strong enough credit history to qualify for a small business loan.
If you’re a small business owner with a short-term need, you might find a personal loan is a good choice for you if you don’t qualify for other small business loan options. Make sure you have a repayment plan in place. If your business fails, you could be held personally responsible for the terms of the loan.
Medical bills, especially following an injury or serious illness, can be daunting. One thing is for sure, and medical providers will be tenacious in seeking payment. If you want to avoid collections for your medical bills and just get them paid off, you could consider a personal loan.
Make sure you first have a conversation with your medical provider. They might be willing to work with you on a repayment plan that will be better than paying interest on a short-term personal loan. Often those repayment plans don’t come with interest, so they offer quite a savings compared to a personal loan.
Bad Reasons to Get a Personal Loan
There are some times when it just doesn’t make sense to get a personal loan.
Anytime when you could be patient and save money towards what you want or need and avoid paying interest, you should. You will save money over the long term and avoid impacting your credit by applying for and taking out a loan.
Vacations and luxury purchases are probably other places where personal loans don’t make much sense to get. Since these kinds of purchases fall into more the want category than the need, you should probably just save towards them and not have to pay interest on the loan.
If you’re a student struggling with school expenses, you might wonder about a personal loan. You’re likely to get better terms from a student loan than a personal loan. You will also get longer to pay them off. Taking out a personal loan for school expenses might mean you’re required to make high monthly payments before you’re actually graduated and employed from school.
Types of Personal Loan Lenders
It used to be the only place to get a loan was from your local brick and mortar banking location. Technology has greatly changed the world of finance. This also means there are now a variety of ways you can seek a personal loan.
Sure, you can still gather up your paperwork and visit your local bank branch. But it’s not the only option anymore. This type of loan is considered direct lending. You went to the source of the loan, sought financing, and they provided the loan.
Now you can also talk with an aggregator about your loan options. This person gathers your information then shops for different lenders to find you a loan. This works much the same way a mortgage broker would find you the best mortgage terms.
There are also online sources that do peer-to-peer lending. This means you enter your information, and a lender enters their criteria for a loan, and the site matches you up.
How Does a Personal Loan Work?
You might be wondering how it works to get a personal loan. The steps are pretty straightforward once you actually apply and are approved. More on this step a later.
The money for a personal loan is paid in one lump sum and is often deposited directly into your bank account. Remember, you want to have a plan for your intentions for the loan money, as your terms for paying it back start as soon as you receive the money.
Most personal loans are not secured (more on this shortly), so there isn’t collateral like a car or house that you could lose if you don’t repay it. This is the reason you’ll often pay a higher interest rate because the loan is riskier without collateral.
Once you receive payment, you’ll be expected to start making monthly payments until the loan is paid. The terms of the loan include what interest rate you’re paying and how long you have to pay it off.
Prequalifying for a Loan
As you consider a personal loan, you’ll want to look for the best terms possible. Interest rates can vary greatly depending on your credit history and personal credit score.
If you’re serious about seeking a personal loan, you will want to go through the prequalifying step with lenders. Many lenders won’t run a full credit check to prequalify you.
By getting prequalified, you can consider the terms of the loan the lender is offering.
Steps to Applying for a Personal Loan
When you think you’re ready to apply for a personal loan, here are the steps you should follow.
First, you want to know how much you want or need to borrow. This matters because different lenders offer different amounts. Some lenders only offer loans up to a few thousand dollars, while other lenders offer larger amounts. Once you know how much you want to borrow, you can narrow down lender options.
Since lenders have different lending standards, you want to check your credit report and credit score to make sure it fits the lender’s standards.
Again, because terms can vary greatly from lender to lender, you’ll want to do your due diligence and shop around to find the best lender for you. Once you have found a good fit, submit your application. Make sure you know the interest rate, term to repay the loan and ask if there are prepayment penalties if you can pay off the loan early.
Then it’s a matter of waiting for approval and funding. Unlike loans like a mortgage, the wait time is usually very minimal for a personal loan application.
Personal Loan Terms
You want to be aware of the vocabulary related to personal loans so you can best understand a loan. Here are some terms to know:
- Loan Terms: the comprehensive list of conditions attached to the loan, including how long you have to pay it back, interest rate, and penalties for late payments
- Loan amount: the amount being borrowed
- Annual percentage rate: the interest amount a borrower pays in a year on the outstanding balance of the loan
- Monthly payment: the amount due each month to pay off the balance of the loan
- Prepayment penalty: a fee many lenders include that’s tacked onto the loan if you pay it off early
Another feature offered by many lenders is a personal loan calculator. This feature allows borrowers to input potential features of their loan to fully understand long-term cost and how the terms of the loan impact it.
Secured Loans vs Unsecured Loans
Most personal loans are unsecured loans vs secured loans. A personal loan is based on your own personal standing, like your credit score and credit history. So, the lender considers whether you’re a smart risk and likely to pay back the loan.
In a secured loan, there’s collateral secured in case the loan isn’t paid back. In this case, if the loan payments aren’t made, the lender can take the collateral to act as repayment for the loan.
Unsecured loans are one of the reasons that interest rates are higher for personal loans.
Considering Personal Loans
If you’re considering a personal loan, there are some positives.
The application process for personal loans is relatively fast and easy. You can ask for different amounts and even set up your repayment terms to fit your needs. Because personal loans are discretionary, you can use them for the purpose you need without having to explain them to the lender.
Often the interest rate of a personal loan is actually better than you might get from a credit card too. Depending on the lender, you can also get higher larger sums than might be available on a credit card.
Another advantage is that personal loans rarely require any type of collateral to secure them.
On the other hand, there are some potential negatives to a personal loan. Even though the interest rate might be better than a credit card, the payment amount is often higher because you have a limited amount of time to repay the loan’s balance.
One way personal loan lenders make money is through fees and penalties. These can be steep if you pay late or even try to pay off the loan early.
Top Questions to Ask Before Getting a Personal Loan
Anytime you seek financing where it will cost you money, you want to have as much information as possible related to the loan. Here are some common questions related to personal loans.
Will My Credit Score Be Affected By a Personal Loan?
The short answer is probably. It can impact your credit score short term negatively. If you have bad credit, being a responsible borrower can mean it could help your credit score.
Your loan will impact your score because it will use up some of the available credit you’re eligible for and show up on your credit report. It can also impact your score negatively when you actually submit the loan application.
Long term, paying off a loan can help your score.
How Will Debt to Income Ratio Impact My Loan?
A lender will consider your debt to income ratio when looking at your application. They will want to know how much debt you already hold in relation to your yearly gross income. This is especially true with personal loans since there isn’t likely to be collateral.
Is My Credit Good Enough for a Personal Loan?
One of the reasons many seek personal loans is because they are often available to those with poor credit. Be aware, though, the terms are often not desirable. If you have poor credit, you should carefully consider other alternatives.
How Long Does It Take to Pay Back a Personal Loan?
This will depend on the terms of your personal loan. Any time you seek money as a borrower, you want to repay the money as quickly as you can afford it. Having said that, most personal loans are shorter term than some other borrowing options. Rarely does a personal loan exceed 60 months to repay it.
What Fees Should I Expect From a Personal Loan?
Personal loans often come with a laundry list of fees. This might include everything from the application and loan origination fees to late payment fees. Often personal loan lenders will charge an early repayment fee, too, since they make their money by you paying the whole term of the loan.
Understanding Everything You Need to Know About Personal Loans
Anytime you consider borrowing money, you want to have as much information as possible about the loan and what it will cost you. Certainly, your lender will want to know a lot about you for a personal loan. They’ll want the basics like your credit score and income and will calculate your debt to income ratio as they consider your loan.
As you work on your financial picture, you also want to make sure all your insurance needs are covered. Please don’t make the mistake of making a big purchase and fail to properly insure it too. We can help with whatever your insurance needs might be. Contact us today to discuss your insurance needs and get a quote too.