If you’re paying off multiple credit cards — or you have a big upcoming expense like a wedding or dream vacation — a personal loan can be an effective and efficient way of getting the cash you need quickly, often within days of applying.
Navigating personal loans can be tricky, however. Here’s some information and guidance to help you understand how to get a personal loan.
Why a personal loan?
Far and away the most common reason someone takes out a personal loan is to consolidate debt. Rather than pay off multiple creditors, borrowers can use a personal loan to pay off all outstanding balances and then only contend with one monthly payment, for the loan itself.
But a personal loan can be used to fund any major expense, including home improvements, weddings, vacations, adoptions or medical expenses. It’s a way to get an influx of extra cash, to afford something that would otherwise be out of reach.
What is a personal loan?
Personal loans are typically unsecured loans, meaning a lender loans you money without requiring any collateral. This type of loan differs from a secured loan like a mortgage, in which the collateral is the home or any other real estate you buy.
If you default on your mortgage, the lender can take possession of the collateral — your home — and sell it to pay off your debt.
In the case of an unsecured personal loan, the lender decides whether to loan you money — and under what conditions — based solely on the likelihood you’ll pay it back (i.e. your creditworthiness.)
Since you’re not putting up any collateral, this set-up is riskier for the lender, so unsecured loans can come with higher interest rates and shorter repayment terms.
Personal loans are not the only type of unsecured loan available. A payday loan, for example, is also unsecured but differs in important ways. Payday lenders don’t do credit checks, and instead, give small loans that you promise to repay when you get your next paycheck. Often you will give the lender a check dated for your next payday for the loan amount plus a fee.
Payday loans are typically very costly and risky for borrowers and are usually seen as a quick fix for an immediate financial emergency, particularly for people with very poor or no credit histories. Fees are high, $15 or more for every $100 borrowed and, if your check bounces, you’ll pay bank charges plus huge penalties to the lender. These loans often push people into endless cycles of debt.
A credit card is also unsecured, but is a form of revolving credit. Personal loans gives you a lump sum upfront, which you pay back at a fixed interest rate in a set number of consistent monthly payments. Often, the interest rates are lower than credit cards and the fixed monthly payments make them attractive to people who like predictability in their monthly budgets.
What are the rates and terms of a personal loan?
Typically someone can take out a personal loan for $3,000 to $50,000, but loans can be as little as $1,000 or as much as $100,000. Interest rates typically fall between 5% and 36% for terms of three to five years.
The better your credit, the better your rates and terms, although specific offers for the same applicant vary from lender to lender.
When is a personal loan not the best choice?
Take stock of your creditworthiness. Depending on your credit score, a personal loan may not be your best option.
If your credit is excellent, generally a FICO score of 720 or above, you will likely qualify for a credit card with a 0% introductory rate that lasts six to eighteen months, for purchases and, in some cases, balance transfers.
If you can make the monthly payments and pay off the balance on that new card within that introductory period, you essentially get a loan with no interest at all, something no personal loan offer can beat. This may be the best option for the most responsible, financially healthy candidate.
On the other hand, if your credit score is poor, below 580, you will likely not qualify for a personal loan.
In that case, you can look into a secured personal loan, which is an uncommon set-up but may be available to you. If you have a savings account or CD at a bank, you may be able to use it as collateral to take out a secured personal loan there.
This type of loan requires diligent repayment, or you risk losing your collateral. You can also have someone with excellent credit, who’s willing to pay off your loan if you’re unable, cosign a loan with you. But your best bet may be to hold off on a loan and work on improving your credit first.
Who offers personal loans?
Lenders fall into three broad categories:
Some traditional banks offer personal loans, but often their rates and terms are not the best ones available because they make little money off of them.
Non-profit credit unions generally offer better personal loan rates than traditional banks, and their applications are easier, so they’re good options to consider. You generally need to be a member to take out a loan from a credit union, so you’ll need to go through the membership process first if you don’t already belong to one.
The new crop of online lenders, including peer-to-peer lending platforms, usually offer better terms than traditional banks. They’ll often loan to borrowers whose credit scores don’t qualify them for bank loans, but who have other positive characteristics — anything from good college grades or social media profiles — that traditional banks don’t usually consider in loan applications. Marketplaces, like Credible, offer a “one-stop shop” for people to submit basic information and compare loans from multiple online lenders in one place.
Applying for personal loans
Taking a few steps will ensure you get a good, cheap personal loan.
- Check your credit history and score: Your credit score is your best indication of what sort of loan you can get. If your score is poor, you can avoid applying for loans that you’re unlikely to get, particularly those from traditional banks. You can also address errors on your credit report before you apply
- Improve your credit: If you have a score lower than 700 and have six months or more before you need the loan, you can work to improve your score. You can pay down credit cards and make all your current monthly payments on time. How long it takes to improve your credit score depends on the factors that lowered it to begin with
- Determine exactly the amount you need: It may be tempting to ask for a little extra in a loan, but you should do the opposite. You’ll likely get the best rates and terms if you ask for the minimum of what you need
- Find out what loans you qualify for: Sites like Credible have short forms used to prequalify you for loans or show you loans you can likely get from multiple landers. Usually you’ll need to submit information about your income, employment, education level and your estimated credit score. You’ll be able to compare offers before submitting a formal application
- Collect the information you need: Most personal loan applications require you submit proof of address, whether your own or rent, information about your employer, your income, and your social security number at a minimum. Be prepared to provide accurate information
- Submit applications: Online lenders have applications fully online, making them a convenient option. Traditional banks and credit unions generally have online applications, although some may follow up by phone. You can also go into your bank branch to apply, too. Keep in mind banks typically have minimum credit-score requirements to borrow, so know first if you qualify.
You’ll want to have at least three offers to compare. It’s tempting to make your selection based purely on the interest rate and the monthly payments. But you’ll want to check the fine print so you can better take into account the total cost to you.
Other considerations include:
- Origination fee: Lenders often add on a percent of the loan amount, typically 1 to 6%, to cover their costs to set up the loan for you
- Pre-payment penalties: Some lenders don’t want you to pay off your debt early, and will penalize you if you do so. The amount can vary depending on when in the loan’s life cycle you pay it off
- Late fees: Lenders typically tack on a fee for late monthly payments, either a percent of the monthly payment or a flat amount
- Scams: It goes without saying, but you’ll want to ensure your lender is reputable. If the offer is too good to be true, or if the lender has asked you for very little personal information before promising you money, steer clear.
Finally, if you’re currently paying off a personal loan but want to reduce your payments — either by lowering the interest rate or extending your current payments over more months — you can see about refinancing your loans, which essentially means taking out a new loan with better terms to pay off your current one.
It is always best to shop around to make sure you are getting the right loan for you. And remember, f your credit has improved since you took out a previous loan, you may now qualify for something better. And you can use that new loan to pay off the older one that may have worse terms.