Personal loans are ideal for small emergencies and big-ticket purchases. But with so many options to choose from, finding the perfect loan product that has favorable terms and suits your needs can be quite the task.
In this guide, you’ll learn more about how personal loans work and what you need to qualify, along with some tips to keep in mind before applying.
How personal loans work
In a nutshell, personal loans are a form of installment loans that are unsecured. The lender issues you a set amount of funds and expects to be paid back within a certain timeframe. Oftentimes, consumers use loan proceeds to:
- Get back on track financially after going through a rough patch
- Consolidate debt to get a lower rate and make monthly payments more affordable
- Cover big-ticket purchases, like a wedding or dream vacation
- Take care of the unmet financial need for higher education
- Pay for home improvement projects
- Pay for medical expenses
Furthermore, most personal loans are not backed by any form of collateral, like a car or home, because they’re unsecured. This makes them less risky since your personal assets won’t be at risk. But in the event you are unable to make payments and default on the loan, your credit rating could take a hit.
Key benefits of personal loans
You can use the proceeds of a personal loan to cover just about any type of expense you can think of. The lender won’t be looking over your shoulder to see how you spend the money. Their primary concern is that you make timely payments.
No need to dig through a loaded filing cabinet or stack of papers to find your auto title. And you also won’t have to put your home or any of your other valuables on the line.As mentioned earlier, most personal loans are unsecured, so there’s no need to put up collateral to get approved and receive the funds you need.
Another major benefit: you won’t be at risk of losing your primary form of transportation to get around or your place of residence if you default on the loan.
Competitive interest rates
The interest rates that accompany personal loans are usually more competitive than what you’d find with credit cards, cash advance or title loan products.
This is a major benefit if you’re looking to consolidate credit card or other high-interest rate debt to pay off the balances faster. But keep in mind that a lower credit score could mean higher rates.
Even better, most personal loans have fixed interest rates, which means you won’t have to worry about your monthly payment skyrocketing in the middle of the loan repayment period. The rate you receive when the loan application is approved is the rate you’ll keep until it’s paid off.
Lengthy repayment periods
Unlike payday loans, you’ll have several months or years to repay the loan in full. This makes taking out a personal loan more affordable to consumers since the sum of principal and interest is broken up into small increments, payable each month.
Streamlined application process
Most personal loan applications take just a few minutes to complete. Expect to answer questions regarding your:
- Personal information, including your name, date of birth, physical and email address, and phone number.
- Citizenship status: In most instances, you’ll need to be a US citizen or permanent resident with a valid Social Security number to qualify for funding.
- Finances: Lenders are interested in learning more about your other debt obligations to determine how much you can realistically afford to pay each month to satisfy your prospective obligation with them.
- Employment: The lender may contact your employer to confirm your employment.
- Income: This amount will determine your ability to repay the loan and the amount that should be loaned to you. Self-employment income, government benefits, and alimony may suffice.
- Military status: There are strict rules governing personal loans for individuals who are actively enrolled in the armed forces.
Rapid approvals (for online loans)
In most instances, you’ll know if you’re approved for a personal loan the same day. And if you apply online through the lender’s website or via a loan search engine tool, you could receive an answer within minutes or seconds.
Keep in mind that approvals are contingent upon the verification of the information provided in the application. So, be prepared to provide personal identifying information, proof of income, and banking information to substantiate your claims. The latter will be used to disburse loan proceeds when the application is finalized.
Some lenders offer to fund the loan in as little as one business day. If you’re going with a traditional brick-and-mortar lender, you should receive the funds in your account within three to five business days, but some offer faster funding options for a fee.
Less than perfect credit ok
If you’ve had credit troubles in the past, you may encounter more difficulty than usual when searching for a personal loan. However, there are lenders that cater to consumers with less than perfect credit. And the best way to increase your chances of being approved is by using a loan search engine tool that will shop your information around to their vast network of lenders to find the best possible fit.
Some important considerations
Risk of more debt
Are you using the loan to consolidate debt? If so, you run the risk of racking up even more debt if you’re not disciplined. Why so?
Well, consolidating debt entails moving the debt from one account to another, which in turn means you’ll have a large amount of available credit at your disposal. And if you make new purchases, you’ll end up with double the amount that you started with, which could make it pointless to consolidate debt in the first place.
Fees and penalties
Origination fees between 1 and 6 percent are usually assessed when taking out a personal loan. This amount is factored into the monthly payments and paid back over time. And if you wish to pay the loan in full before the repayment period ends, you could be assessed a prepayment penalty.
Qualification criteria for personal loans
Wondering if you qualify for a personal loan? Each lender has their own set of qualification criteria, so it’s possible to get a no from some lenders and a yes from others.
Most lenders have a minimum criterion for credit scores and if your score isn’t up to par, your application may automatically be rejected. If not, expect a higher interest rate to compensate for the increased level of risk you pose to the lender.
Why so? Well, since personal loans are unsecured, the risk of loss to the lender is much higher than what it would be with a secured loan product.
So, if you don’t pay up, they don’t have any recourse to minimize their losses, which is why they offset the risk of loss with the interest rate. And having a higher credit score means you pose minimal risk, and vice-versa.
Another major factor in the loan application review process is your income. Having good credit is important, but so is your ability to repay the loan. For this reason, the lender will consider your income to determine how much you can afford to pay each month without being overextended. The monthly payment amount, coupled with the interest rate, ultimately determines the loan amount and repayment period.
Before you apply
1. Check your credit
Creditworthiness is one of the primary factors used by the lender when deciding whether or not to approve your application and at what rate.
So, it’s a good idea to check your credit to see where you stand so you won’t be off guard if the lender finds negative information you had no knowledge of.
When reviewing your report, look for inaccurate or untimely information and file disputes promptly. For negative information that is correct, devise a plan of action to remedy it before applying.
But if you can’t afford to wait, be prepared to receive a higher interest rate. Otherwise, it may be worthwhile to work towards a higher score so you can pay less in interest over the life of the loan.
2. Evaluate lenders
Not all lenders are created equal. They come in all shapes and sizes, have different qualification criteria, and offer loan products with varying repayment terms and interest rates. Also, keep in mind that all lenders aren’t what they appear to be, and there are tons of scammers lingering around waiting on cash-strapped consumer to fall victim to their deceptive schemes.
So, you’ll have to do your due diligence to confirm you’re dealing with a reputable company. A few things to be on the lookout for:
- Secure website: The website URL should read “HTTPS” and not “HTTP”. Otherwise, it’s not secured and any information you enter could be swiped by a cyber-scammer lurking around the web.
- Contact information: Does the company have contact information listed on their website? If they’re online, they should still have a physical address where customer inquiries can be sent. They should also have a customer service representatives that can be reached by phone.
- Better Business Bureau (BBB) accreditation and rating: Are they a BBB accredited business? And if so, how are they rated?
- Customer reviews: What are customers saying about them? If a bulk of the reviews are negative, that’s a good indicator that the service they provide isn’t up to par and you should look elsewhere. And if you happen to spot a slew of reviews that sound too good to be true, they probably are.
- Bogus fees: A reputable lender won’t ever ask you to pay an application fee to move forward with the process.
3. Shop around for rates
You want to ensure you receive the most competitive rate on the market for your financial situation. So, it’s best to shop around with at least three lenders before making a decision. Or you can make your life easier and save a ton of time by using a loan search and comparison tool to do the legwork for you.
4. Run the numbers
Use a loan calculator to get an idea of how much your monthly payments will be based on the amount you want to borrow. If it’s too high, consider applying for a smaller amount to minimize the risk of default. Otherwise, you could damage your credit.
5. Devise a strategy to repay the loan
There’s no need to only pay the minimum each month if you have extra funds at your disposal. Instead, pay the loan of as soon as possible to save on interest, but be sure prepayment penalties won’t apply.