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Most commonly offered by financial institutions such as banks, credit unions and online lenders, personal loans are usually granted based on your credit history, income and other aspects of your financial profile. Essentially, the lender will trust you’ll honor your repayment obligation based on the degree of financial responsibility you have demonstrated in the past. Typical uses for personal loans include student loans, home improvements, emergency expenses, medical bills and debt consolidation. In this complete guide, we’ll discuss what a personal loan is, how it works and what you need to do to get one.
Types of Personal Loans
Personal loans come in a variety of types, each of which is better suited to certain situations than others. The primary types include secured, unsecured, fixed rate and variable rate, as well as peer-to-peer. Each of these has certain advantages, as well as drawbacks.
Secured vs Unsecured – The most common type, unsecured personal loans, require no collateral, but do require strong credit. Secured personal loans, which require collateral, are good for people whose credit histories are less than ideal, as the asset pledged to secure the loan provides the lender with a means of recouping their funds if a borrower defaults on the loan.
Fixed vs Variable Interest – Most personal loans carry fixed interest rates, which means the interest rate and monthly payment remain the same throughout the duration of the loan. This makes them an easier fit into personal budgets. Variable rate personal loans can be less expensive than fixed loans, initially. However, variable interest rates fluctuate in concert with benchmarks such as the prime interest rate. This can make them more expensive to maintain as time goes on if interest rates increase.
Peer to Peer – Available online, peer-to-peer personal loans bypass traditional sources such as banks and credit unions. Borrowers submit applications using peer-to-peer lending platforms. A degree of risk is assigned to a borrower’s application based on their credit history and investors decide whether to take a chance on them. Peer-to-peer loans can be less expensive for borrowers with high credit scores, although origination fees can be higher, as the platform takes a cut in exchange for connecting lenders and borrowers.
How Personal Loans Work
When you are granted a personal loan, you will be expected to repay it in equal payments over an agreed-upon period of time, which is usually seven years or less. Loan amounts can vary from as little as a few hundred dollars to as much as $100,000, depending on your credit history and documented income. In most cases, the minimum credit score you’ll need to qualify for a personal loan is 580 on a scale of 300 to 850. The closer you are to 850, which is considered an exceptional score, the lower the interest rate you should be offered.
Interest Rates – As covered above, most personal loans are offered with interest rates that stay the same over the life of the loan. Consequently, your monthly payment will also remain the same over the life of the loan. The annual percentage rate (APR) on a personal loan typically ranges from 8% to 36%, depending on the lender. Strong credit and a stable income will usually merit rates of 7% to 12%. Fair credit scores, between 580 and 669, will usually get you an APR of 20% or more. This is why personal loans can be more expensive for borrowers whose scores are on the lower end of the spectrum.
Fees – When applying for a personal loan, you can sometimes expect to encounter an origination fee. This can range from 1% to 10% of the loan amount. However, it should be noted some lenders do not impose them, which is why it is a good idea to shop around before applying for a personal loan. You may also encounter application fees and payment processing fees, in addition to late and returned payment fees. Some lenders impose a fee if you pay off the loan early. Known as prepayment penalties, these are designed to garner the lender as much income as possible from your loan.
Collateral – Most personal loans are based only by your good financial history and your promise to pay. However, some lenders do accept collateral on personal loans. This can be useful for applicants whose credit scores are lower, as it can incentivize lenders to offer lower interest rates. Collateral is an asset of greater value than the loan amount, which gives the lender something to sell if the borrower defaults. Real estate, cash accounts, automobiles, investments, fine jewelry, antiques, collectibles and the like can all serve as collateral. The primary criteria are that the asset is valuable, easily sold and unquestionably owned by the applicant.
Pros and Cons of Personal Loans
Among the key benefits of personal loans is their flexibility, as they can be used for a number of different purposes. Most are unsecured, so no collateral is required. Monthly payments are easy to budget because they stay the same with a fixed rate personal loan. Financing a purchase with a personal loan can be much less expensive than using a credit card and personal loans can help you build a stronger credit history if they are reported to the credit bureaus.
On the other hand, personal loans usually entail fees and penalties, which can increase their cost. They also have strict repayment terms, in that you’ll be expected to keep to the loan agreements or face significant penalties. This can become a problem if your income is disrupted. Another consideration of personal loans is that they tend to be single use. You’ll need to apply for another loan if you need more money later. This is not the case with a credit card or a line of credit.
Applying for a Personal Loan
You should review your finances, check your credit score and your credit reports before filling out a loan application. You want to make sure you can afford the monthly payment, without imposing a strain on your finances. Likewise, you’ll want to be sure the information in your credit report is accurate to avoid unpleasant surprises when lenders run credit checks.
Credit Reports/Credit Score – Because interest rates and terms are based largely upon your credit history, you’ll want to know your credit score, and you’ll want to make sure there are no errors on your credit reports. We say reports plural, because you have three. The three major credit reporting bureaus Experian, Equifax and TransUnion all maintain records of your credit history.
While the data those reports contain is largely the same, there can be variances. Some lenders report to one or two, but not all three, so you it’s a good idea to review all three of them. Your credit reports are available for free at AnnualCreditReport.com once per year. If you need to review your credit reports more frequently, you can also pay for access. When reviewing your credit reports, make sure everything they reflect is accurate, as well as up to date.
You may find accounts you closed still showing as active. You may find reports of missed payments even though you’ve made all payments on time. Reviewing your credit report is also a good way to spot identity theft or fraudulent activity in your name. You can learn how to contest errors on your credit report at the Consumer Financial Protection Bureau website.
Your credit score can potentially also be obtained for free from the bank with which you do business. Many banking apps and websites now track credit scores, so you can see yours anytime you’d like for free. Many credit card companies also offer this service on their apps and at their websites.
Documentation – You can save yourself some time and potential frustration by gathering the documentation you’ll need to complete the application ahead of time. In most cases you’ll need proof of your identity and age, proof of your address, income verification documents and bank statements. Additionally, if you’re using the personal loan to consolidate debt, you’ll need statements for the loans or credit cards you’re consolidating with the loan.
Prequalification – In addition to helping you find the best loan for you, seeking prequalification will help you make sure you can afford the loan. If you have yet to do so, nail down the exact amount you’ll need to borrow. Think this through carefully to make sure you’re borrowing exactly what you need. This will help you get a good idea of the expected monthly payment and the interest rate lenders will want to charge you.
Another benefit of pre-qualification is it will help you find the best loan while keeping your hard credit checks to a minimum. One aspect of your credit score is the number of times you’ve applied for credit within a short period. Multiple hard credit checks can reduce your credit score. Soft checks, which are used for pre-qualifications, do not. This enables you to find the best loan offer without diminishing your credit score.
Completing the Application – Most lenders these days accept personal loan applications online. Having all of the aforementioned documentation at hand will make filling out the application go more quickly. You’ll need to provide some basic personal information, as well as the amount you’d like to borrow and the loan purpose. If you’re applying with a co-signer, they will also need to provide that data. If approved, you’ll typically have the money within days – sometimes even the same day.
In Summary
Personal loans can be of significant benefit under the right circumstances. They are especially beneficial for people who have strong credit histories, stable incomes and one-time funding needs. However, if you need cash fast and your credit history presents an obstacle to getting a traditional loan, you might consider an auto title loan serviced by LoanMart.
This type of secured, short-term lending lets you use the equity in your vehicle as collateral to secure the loan. To qualify, you must be at least 18 years old, live in the state in which you’re applying and have a vehicle of sufficient value to support the loan amount you’re requesting. Because your title serves as collateral, your credit history isn’t a significant determining factor, as it is with a personal loan. Apply for your LoanMart-serviced car title loan today. You might be pleasantly surprised to see how quickly and easily you can have the cash you need in hand.1
