What is a Personal Loan?
In this article, we will cover the ins and outs of a personal loan, and whether or not taking one on is the best choice for your unique situation. These loans can be used for a wide range of purposes, and we will go through all the details and show you how you can apply and get a competitive interest rate.
What We Will Cover
- What is a personal loan?
- When is a personal loan a good idea?
- When is a personal loan a bad idea?
- How to apply (including calculator)
- Loan application checklist
What is a Personal Loan?
A personal loan can be furnished by a financial institution or an alternative online lender. They usually have fixed interest rates and can be paid back in installments typically ranging from two to seven years. They can be used for many reasons including home projects, buying a car, life events (like divorce or funeral expenses), and even vacations.
The underwriting process takes credit history, credit score, cosigner worthiness (if applicable), and other factors into account to determine the risk associated with approving the loan. This helps the lender determine your interest rate as well as how much you will qualify for. Loans typically range anywhere from $1,000-$50,000.
When is a Personal Loan a Good Idea?
A personal loan is ideal when assets are not part of an equation (AKA a non-secured loan) and when the interest rate is more competitive than other types of loans. Here are some good reasons for this type.
- Debt consolidation makes sense especially in the case of high-interest consumer credit cards. The idea is that you combine various forms of high-interest debt into one manageable payment with an improved interest rate.
- Vacations, big ticket items, and holiday shopping may be a good reason if you are able to get a solid rate and are committed to paying it off as soon as possible. Ideally, these are things you would save up for, but a loan may get you a better rate versus a consumer credit card or financing through other means. Just be careful not to take out more than you can manage.
- Personal events can sneak up on anyone, and borrowing can help fill in the gaps for expenses you did not think to plan for. Whether it is a surprise wedding expense, paying for a divorce lawyer, funeral costs, or another event, you can take out a loan to secure the funds you need quickly and easily.
- A loan for a home renovation project can help you build your dream kitchen or do a budget remodel as you prepare to put your house on the market. Typically, though, it makes the most sense to take out a loan if you plan to stay in the residence and want to enjoy the renovation. Many people take out a home equity line of credit (HELOC) which is a secured loan that uses the home as collateral. Keep in mind that this type of loan requires at least 20% in equity and a solid credit score.
When is a Personal Loan a Bad Idea?
- Auto and big-ticket item financing where assets are used to secure the loan usually trump the benefits of a personal unsecured loan. When you use the item you are purchasing as collateral, you can almost always get a better rate as a result. You certainly want to be careful where you borrow, as many in-store financiers charge higher interest rates than a bank or online lender. Many car dealerships, for example, will condition their sale prices on whether you finance through them, and you can be sure you can get a better interest rate elsewhere.
- Student loans are also better served through products designed to cover college tuition and other associated costs. These loans are available through the government as well as private lenders and have better repayment terms and benefits than a personal loan. For more information on the various types of student loans.
How to Apply to a Personal Loan
Use this calculator to help determine how much you are comfortable borrowing and gauge your monthly payment. Pre-qualify with a reputable lender committed to working with you to secure the best rate possible.
As you consider your options, here is what you will need to be prepared.
Checklist to Apply for a Personal Loan
- Personal credit score
- ID and proof of residence
- Employment confirmation and income verification including
- W-2 (or 1099 form if self-employed)
- Pay stubs
- Bank statements
- Proof of employment from employer
- Cosigner information (if applicable)
If you are not sure if a personal loan is the best for your financial need, here are some frequently asked questions.
Q: Is a secured loan a good idea so that I can get a better rate?
A: Personal loans are unsecured, but borrowers with bad credit or those looking for a better interest rate can take out a secured loan using assets (or the item being purchased) as collateral. Avoid financing through car dealerships, which have higher interest rates than banks or alternative lenders and may offset any sort of sale price or discount they offer.
Q: Can I get a co-signer on a personal loan?
A: Yes, and this will secure you a better interest rate if your credit is low. Check your credit score and consult with your lender to determine whether a cosigner will make a difference.
Q: Are there fees associated with a personal loan besides the interest rate?
A: Although there are no fees for a loan application, there is often an origination fee associated with furnishing the loan based on a percentage of the total amount. This will vary by lender.
Q: What if I want a loan to start a business?
A: If you are trying to start a business or are in need of cash flow for your company, you will want to take out a small business loan instead of a personal loan. There is a broad range of products available that are designed to minimize risk to you as an individual.
By now, you should have the tools you need to apply with confidence. Whether you are looking to remodel your home, cover surprise costs, or consolidate debt, a personal loan can help you streamline your finances and give you peace of mind. We are here to help you every step of the way.