Personal loans are taken out by people who are facing a shortfall in their personal finances. In a nutshell, they don’t have enough money to cover their living expenses or pay for something they want (a car, holiday, new home or college degree). There are many different types of personal loans, most of which have a specific purpose (car loans, home loans, student loans). Personal loans are easy to understand. A lender will give you a fixed amount of money over a fixed period of time. In return, you agree to pay back the amount you have borrowed plus an agreed amount of interest to make it profitable for the lender to loan you the money in the first place.
The basic terms you need to know about when looking for a loan are:
- Fixed Payments – Fixed interest rates that tell you how your loan will be structured. It also means that you will have a fixed monthly repayment for the duration of your loan.
- Term – The number of months you will be given to pay off your loan. You get lower interest rates for longer loan terms.
- Amount – The loan amount will ultimately be the amount you want to borrow vs your credit score and your eligibility for the loan. Some banks can offer personal loans of no more than $10,000, while others like Wells Fargo, can loan you up to $100,000 if you qualify.
- Average Interest Rates – The interest rates you be offered will mainly be determined by your credit score. Your credit score is what banks use to determine your ability to pay for a loan. If you offer assets, such as your home or your car as collateral, then banks will be more likely to lend you money at lower interest rates. But personal loans are usually unsecured loans for smaller amounts, so you won’t be expected to offer up any collateral. The interest rates available via personal loans tend to be higher than a mortgage or an auto loan precisely because of the lack of a collateral asset (the car or house).
When You Should Consider A Personal Loan
- To pay for an emergency expense you have not saved up for. This could be things like car repairs, home repairs and medical expenses.
- To consolidate other debts. If you have multiple debts with different lenders and credit card providers you will likely be able to save money by applying for a debt consolidation loan. Such a loan could offer you a lower interest rate or reduce your monthly payments.
- Buying a 2nd hand car. If you buy through a dealer you will likely be able to get a better rate but if you are buying a second-hand car privately a personal loan may be the best way to fund the purchase.
- Home improvements. Personal loans can be a good option as opposed to borrowing money against the equity in your home. Its easier to arrange a personal loan and your home will not be used as collateral if you fail to keep up with payments.
Advantages of a Personal Loan
- Immediate results. Banks can make a quick decision on your application and release the funds to you within 24 hours.
- Basic documentation. You can get your loan without submitting a pile of documents in triplicate.
- No collateral. No need to risk losing your house or car for personal loans.
- Better rates than credit cards. They are more competitive than credit cards regarding offering better interest rates.
- Confirmed payoff dates. You get to pay your loan in a specified period, so you will know when you will end your loan to eliminate debt.
- To improve your credit score. Loans that can consolidate your debt can work wonders on your credit score. And since it is a fixed amount, you won’t be at risk of spending more money and getting yourself into more debt.
How to Qualify
- Credit Score. The better your credit score is, the better the interest rate you will be offered and the amount you can borrow. Personal loans can be found for those with FICO scores as low as 580 but applying for a loan with a credit score of over 700 will make it far more likely you’ll be approved at a reasonable interest rate.
- Proof of Income. Lenders will ask you how you make money, and how much you earn. This will help give them an idea of how much you can afford to pay in a month and determine if you are capable of paying your debt to them.
- Low existing debt. Lenders will be keen to know what other debt repayments you are making. If you have too much existing debt, lenders will consider you a risky bet and will either reject your application or offer you a high-interest rate to justify their risk.
- Co-signers. This is an additional, optional measure used by banks and lenders to ensure that someone can pay for your loan if you can’t. Parents or other family members are common co-signers in the US.
If you have a history of bad credit or a low credit score, far fewer lenders will be willing to lend you money. You will also most likely pay a higher interest rate. Your alternative options are to put up an asset as collateral but that is risky given your past credit history. Alternatively, you can ask a friend or family member to co-sign for your loan but that is always an uncomfortable position to put a loved one into. If you fail to repay the loan the lender will expect them to make up the shortfall which can lead to a breakdown in relations with your co-signer. You will need to make do with the limited options you have. Look at the limitations in a positive way, a way to help you better manage your debt, prevent you from getting into more financial trouble via easy to obtain loans, and help you work towards a better credit score and long-term financial stability.
For more information check out our Guide To Bad Credit Loans
What Happens If You Can’t Pay Off Your Loan
- Your credit score will take a hit and will go down.
- You will be charged penalties for missed payments.
- Your home and other assets could be at risk.
- Calls from collection agents. Every day.