Personal Loans

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A personal loan can create a buffer between what you need to pay for, and what you can afford right now. This makes personal loans are a great way to cover large costs now and pay back what you owe over time. Our personal loan overview explains what personal loans are, reasons to apply for one, and how to qualify.

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Updated: October 2018

Use Personal Loans to Fund Major Purchases or Consolidate Debt

What is a Personal Loan?

A personal loan is money you borrow from a bank, credit union, online lender, or other institution. You could use the money for just about anything, like buying a car, consolidating debts, or paying for emergency expenses. Most personal loans are unsecured, meaning you don’t put up any collateral. You'll pay the loan back in fixed, monthly payments.

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Reasons to Apply for a Personal Loan

Finance Large Purchases or Cover Expensive Bills

Personal loans make it easier to pay for a house, car, wedding, or any other expensive purchase. The loans can also be used to cover unexpected expenses, like medical bills.

Lower Interest Rates Than Credit Cards

Similar to credit cards, you can use a personal loan to make a purchase today, and pay back what you owe later. One benefit of using a personal loan instead of a credit card is that your loan will typically have a lower interest rate.

Credit card rates vary, but the average APR (annual percentage rate) is 15%. Personal loan rates can vary too, (anywhere from 3% to 35%) however the average is closer to 10%. This makes personal loans an attractive alternative to credit cards, especially for large expenses.

personal loan comparison chart

Consolidate Debt and Lower Interest

Debt consolidation combines multiple debts into one payment. You then pay off that single debt. It also means you only have to pay an interest rate on one loan, which may reduce the amount of overall interest.

credit card vs consolidation personal loan chart

Control Spending and Create a Budget

If you have problems controlling how much you spend with a credit card, personal loans are an option to consider because you can't re-borrow more money on a personal loan without completing an additional loan form. Personal loans also provide a definite repayment amount and period. You can use this to create a monthly budget and improve personal finance habits.

Qualifying for a Personal Loan

To qualify for a personal loan, you need to prove you will be able to pay back what you borrowed, plus interest. Lenders typically make a decision based on your credit score and income. It is important to understand both, as well as your overall debt situation.

Credit Score

Your credit score will determine whether or not you're approved for a personal loan as well as the terms you are offered. Credit scores range from 300-850 and the higher the score, the better your credit rating.

Theoretically, you could get a loan with any credit score. But typically the lower your credit score is, the higher your rates will be.

For instance, a lender might offer a loan with an APR of 5.29% to someone with a credit score of 620. But someone with a credit score about 760 might be able to get a rate of 3.70% on the exact same loan.

Before you start checking out loan options, make sure you know your credit score. You're entitled to get one free credit report each year, and can check your score at:

Proof of Income

Lenders want to be sure you can repay your loan. Be prepared to show that you have a stable, steady income. You could do this by providing recent pay stubs, bank statements, or tax filings.

Understand Your Overall Debt Situation

When you apply for a loan, lenders will look at how much debt you have, either by evaluating your debt-to-income ratio or your credit utilization ratio.

Debt-to-Income Ratio

To calculate this, take the sum of your total monthly debts and divide it by your pre-tax monthly income. Then multiply by 100 to get your percentage. Ideally, you want your debt-to-income ratio to be 36% or less.

Credit Utilization Ratio.

You can find out your credit utilization ratio by dividing your current credit balance by your available credit limit and multiplying it by 100.

Your credit utilization ratio should ideally be below 30%–40%.

What to do if You Have Bad Credit

To get the best rates and terms, you want to focus on improving your credit score before applying for a loan. This takes time, and you may be in a situation where you need money immediately. If you’ve been denied an unsecured personal loan or offered a loan with unfavorable terms, here are two other options to consider: secured loans and peer-to-peer (P2P) lenders.

A secured loan is when you pledge collateral, like a house, in exchange for a loan. Offering collateral makes the loan less risky to the bank, and you might get a better interest rate. But if you default on the loan, you can lose whatever asset is being used as collateral.

Peer-to-peer (P2P) lenders are another option for people with bad credit. These online platforms connect borrowers with individual lenders. The lenders see your credit risk, the amount your asking for, and details about why you need the money. The loans are paid back directly through the lender’s website.

Check out our bad credit loans overview for more information on how to obtain a loan with bad credit.

Preparing to Apply for a Personal Loan

Research Your Loan Options

Before you apply, you want to look around for the best deal based on your situation. In the past you needed to go to a bank and speak with a loan officer to get a personal loan.

Now, you can get a personal loan within minutes over the internet. Most lenders even have a short, online application to see if you'll be approved. The application checks your credit using a "soft pull", which doesn't affect your credit score. This gives you a good idea of what the interest rate will be and the amount you can borrow.

Just confirm it's a soft pull before you submit your information. A "hard pull" does affect your credit, and you don't want a hard pull to show up on your credit.

Red Flags to Look Out for When Selecting a Lender

You shouldn't need to pay any fees to apply for a loan. Someone charging you an upfront fee might be trying to extract money and once paid, will simply tell you that you've been rejected. Likewise, any request to wire money should be a red flag.

Here are a few other things to watch out for when considering a lender:

Lack of Disclosure

You want full disclosure of all documents and fees associated with your loan. You should be very wary of any lender that doesn't disclose all this information.

No Credit Check

Any legitimate lender should be doing a credit check before considering you for a loan. Even if it's just a soft pull to determine your initial eligibility and what rates to offer.

No Documentation

You want all of the terms and agreements regarding your loan in writing. If your lender isn't able or willing to provide paperwork, something is probably up.

No Physical Address or Ability to Contact by Phone

Any lender's website should have a clear "About Us" or "Contact" page with the organizations' full address and phone number.

Research every prospective lender, especially if you question its legitimacy. Call the phone number provided, look the lender up in the Better Business Bureau (BBB), or search online for "(lender company name) scam" to see if any complaints come up.

Unprofessional Email Address

Lenders won't use a free email address on sites like Hotmail, Gmail, or Yahoo. They should have their own business email with their registered domain.

Overly Pushy

If a lender or their salesperson is coming on too strong, it's a good sign that you should take a step back.

He or she might try to get you to overstate your income, sign up for a loan with unfavorable terms, or try to talk you into taking loans you don't need.

Do not apply for a loan if you don't trust the lender or are worried about paying it back on time.

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Paying Back Your Personal Loan

Repay Your Loan On-Time

One way to ensure you never miss a loan payment is to set up auto-payments.

When available, auto-paying is the most efficient option. Just set up a direct withdrawal once. Your payment is then automatically sent from your bank to your lender each month.

Alternatively, you can pay online, over the phone, or by mail.

Online payments are quick and convenient. You can make online payments in your pajamas at 11 pm on a Saturday if you want!

To pay by phone you'll need to call when there are staffers available to take your information. If you choose to pay by mail, remember to leave several extra days in advance for your payment to travel through the postal system and get processed.

Late and Missed Payments

Late or missed payments can negatively impact your credit score.

Once you're over 30 days late, your lender may get a collection agency involved. This third-party company will call and write to you to try to recover the overdue payment.

Being 60 days late on a payment will hurt your credit score even more. Missing a payment by 90 days or more can cause significant long-term damage to your credit.

If you think you're going to struggle to make your next payment, it's always better to contact your lender and try to work out a deal.

Most lenders would rather get paid a little less than not get paid at all.

Paying Off Your Loan Early

Read the fine print before you sign up to know if your loan includes a prepayment penalty that charges you if you try to repay early.

Reasons Why an Application May Get Declined

Poor or thin credit history, or a recent bankruptcy are two reasons why you could be denied a personal loan. Other reasons include:

Frequent Inquiries

Inquiries are when a potential lender runs a hard credit check on you. Too many inquiries can be seen as a red flag by lenders.

Discrepancies or Inaccuracies

If there are errors or discrepancies in your credit report or loan application, you'll probably be denied a personal loan.

That's why it's vital to check your credit report regularly and make sure everything is accurate. Be sure to look over your credit report and application carefully before you apply.

High Debt Ratios

A high debt-to-income ratio or credit utilization ratio signals to prospective lenders that you're reaching the limit of what you can pay off each month. Lenders will wonder if you'll miss payments or default on your loan.

Unstable Employment

Lenders want to see something tangible to prove you're making money, like a paystub. If you're unemployed, self-employed, or doing temporary work, you might need a cosigner in order to get a personal loan.

Additional Information About Applying for Personal Loans

Applying for Loans Impacts Your Credit Score

When you submit a loan application, lenders will do a "hard credit pull" where they look at your credit report. A single hard pull probably won't negatively impact your score too much, but multiple inquiries in a short span of time will.

Once approved, if you fail to pay on time or default on your loan, your credit rating will drop, and you'll incur penalties from your lender.

For secured loans, the lender might take whatever you've put up as collateral.

Be Sure to Read the Fine Print

Carefully look over all documents associated with your loan to ensure you understand the terms, and there aren't any extra charges or fees.

For instance, you may want to pay back your loan early but could be charged for doing so if your loan has prepayment penalties.

On loans with precomputed interest, you won't be charged for paying early, but doing so won't save you money either.

Precomputed interest is a method of calculating loan payments where all interest for the term of the loan is added to the principal amount. Paying early doesn't save money because all the interest is added into the loan from day one.

But you should be able to find a personal loan without an extra charge for loan insurance.

Origination fees are fees a lender charges to process and manage the loan. The actual fee amount varies between lenders, and some online lenders don't charge them.

Understand the Interest Rates & Payment Terms

Find the lender that can offer you the lowest rates and payment terms that will work for your personal situation.

Look for payment terms that don't charge a prepayment penalty. Particularly if you think that paying off your loan early might be a possibility for you.

Research Your Credit Score

Get a copy of your credit report in advance and check it for errors or issues that might be lowering your score.

Shop Around

Look at different lenders and all of the options they have available to find the deal that's right for you.

Figure Out When You'll Get the Funds

The approval and disbursal process will vary based on factors like who your lender is and how much you applied for. It could take three days to be approved by a bank and another business day before the money is deposited.

On peer-to-peer or other lending sites, you may be approved and have the loan disbursed that same day. Make sure you understand the process and timeline before you apply for a personal loan.

Most banks and P2P lenders will deposit the funds, minus any fees, directly into your bank account. If you're using the loan to pay for something specific like a car, your bank can send the funds directly to your debtor. This also occurs with debt consolidation loans.

Consider Refinancing

Once your loan has been approved, you're usually tied to its terms until it's paid off in full.

However, you can try to refinance your loan on more favorable terms.

Refinancing is when you take an existing debt and replace it with a different debt.

For example, if you signed up for a personal loan with a 15% APR but then you find another lender willing to give you a loan for 10% APR.

You can refinance your loan by taking out more funds at 10% and using them to pay off your 15% loan in full.

Refinancing your loan might also allow you to change the terms of your loan to a shorter or longer period.

If your credit score has improved since you initially took out your loan, it's worthwhile to see if you can now get better terms and rates.

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