Here’s What You Need to Know About Personal Loans
Consumers who are looking for new ways to secure financing might want to consider a personal loan instead of credit cards or secured loans. Personal loans can be an inexpensive way to consolidate high-interest debt, fund a business endeavor, cover an emergency or even pay for an unexpected tax bill. These loans are particularly attractive to borrowers because the terms and rates are lower than other forms of unsecured loans, the application process is relatively quick and easy and the borrower doesn’t have to put any personal assets at risk to secure financing.
Personal loans are unsecured, meaning there is no collateral, like a car or house, to guarantee the loan. For example, a mortgage loan is secured by a property, and a vehicle secures a car loan. If you default on a secured loan, the bank can seize the asset. If you fail to repay an unsecured personal loan, the bank does not have collateral to go after. This makes the loan less risky for the consumer and a greater risk for the lender. Because of this, lenders generally charge higher interest rates on personal loans than on car or mortgage loans, but lower interest rates than credit cards, another form of unsecured loans.
Related: How to Convince Lenders to Give You a Loan After Filing for Bankruptcy
Personal Loan Interest Rates
Your credit history is the biggest determining factor in whether or not you qualify for a personal loan and what the interest rate will be. Financial institutions use “risk-based” pricing, which looks at the consumer’s credit score and credit history to make lending decisions. The better your credit, the better your interest rate and the more options available to you. If you have bad credit, you might pay a higher rate or even need to get a cosigner to get approved for the loan.
The interest rates and terms on personal loans are fixed, which is one of the biggest draws for borrowers. There are no unpredictable interest rate hikes, confusing terms or ballooning monthly payments. Consumers like the predictability and discipline of the set terms and payments; they don’t get that with credit cards and lines of credit.
The interest rates on unsecured personal loans are higher than secured loans, but they are usually better than credit cards, which is why so many borrowers use them to consolidate debt. Rates vary by lender and the consumer’s credit history, but they are generally low. For example, a customer with good credit looking for a $6,000 loan with 36-month terms could be able to secure a rate of 8.36% APR with a peer-to-peer lender, meaning a monthly payment of $181.66.
On the other hand, a customer with $6,000 in credit card debt and the national average interest rate of 15.07% will have to make monthly payments of $208 to pay off the debt in 36 months. That difference will cost the borrower nearly $950 more over the life of the loan.
Getting a Signature Loan
Signature loans are the most common form of unsecured personal loans. Just a signature, nothing else, secures these personal loans. Signature loans are available at banks, credit unions, credit card issuers and peer-to-peer lenders, like Lending Club and Prosper. Borrowers can also find discounts with lenders like special interest rates for premier customers or members of the military. The personal loan industry is broad and there are many lenders and attractive offers to choose from, so consumers should shop around before deciding on one.
Read: How Much Money Can I Get With a Personal Loan?
How to Get Approved for a Personal Loan
Personal loans aren’t necessarily easy to get; after the financial crisis, lenders tightened up their practices and began to look at applicants with a more critical eye. It’s important to present a good package for the lender to review if you want to get approved and secure good terms.
Here are some ways to improve your chances of getting approved for a personal loan:
- Do your homework: Check out various offers online before heading to your typical bank of choice. You might be surprised what an online bank or peer-to-peer lending site can offer compared to the bank you use now.
- Know what you want: Understand what kind of loan you are looking for, the terms you can afford and how long you want to take to pay the loan off.
- Get your credit report: You need to know where your credit stands before you start shopping around for a personal loan. If you plan ahead, you can correct any potential errors on your report or try to raise your score before the bank pulls your history.
- Don’t wait until the last minute: Applying for any loan in a hurry is a bad idea and leaves you vulnerable – you might make a bad decision or be forced into a less-than-desirable loan package. In some cases, the lender might ask for extra documentation or have extensive follow-up questions for you. Leave enough time for them to do their due diligence without putting you in a financial bind.
The Bottom Line on Personal Loans
While an unsecured personal loan is a great option for many borrowers who need quick cash or who are trying to pay off high interest debt, it’s still debt. Consumers should only apply for a personal loan if they are committed to paying if off and not racking up more debt in the meantime.
Be honest and clear with yourself about why you need this money and how you will pay it off. Paying off a loan takes discipline and you don’t want to jeopardize your financial future.
Photo credit: Wade Morgen
