Think you know a lot about getting a personal loan? Check your credit rating, compare rates, and do your research, right?
Not so fast.
There are some crazy opportunities out there for personal loans, like payday loans which often cost more in interest than the actual loan amount!
If you don't know enough about personal loans and how to use them, you could end up paying way too much.
We think we know how to use personal loans and how to make the most of them. But when we're wrong, we make long-term, costly mistakes. For example, the market for personal loans has exploded, and there are lenders competing for your business.
Borrowing money via a personal loan is an important financial decision that can affect you for years.
Without careful consideration, you could end up with a high-interest rate, causing you to spend too much every month just to pay down principal. One family member had taken a personal loan once for an unexpected car repair. Unfortunately, the loan ended up costing them triple what the repair costs were, and took almost three years to pay off while they maintained their normal monthly bills.
This mistake can live on to haunt you. Overpaying on one loan affects how much available income you have, and therefore how much you can invest. Unfortunately, credit cards remain the most common and expensive way Americans borrow money.
And credit card debt is climbing. Currently, the average credit card interest rate is 18.76% and the average household pays a total of $1,292 in credit card interest each year, according to CNBC.
Consequently, people in the United States are strapped for cash. The Federal Reserve conducted a poll that showed 47% of American households cannot even cover a $400 emergency expense.
When you live like that, it is likely to continue. Such a financial decision can impact you for years. How you're borrowing and repaying your debt now affects how your life will be in five years, 10 years, and even 30 years.
Personal loans can help stop the snowball effect of revolving debt.
They allow you to have a fixed repayment plan for the short term and climb out of debt. Even if you have been on the revolving debt merry-go-round for years, all it takes is some concentrated effort and planning to reset your financial life.
First, let's confirm what is a personal loan. We're not talking about no-check payday loans, which allow you to take out thousands of dollars with barely any proof of income. We're talking about secured or unsecured personal installment loans. What's that?
Secured means you put up some collateral as a backup, in case you don't pay. This raises the chances you'll get a loan and can help lower the interest rate you'll be charged. For example, a car loan is a secured debt. If you fail to make your repayments as outlined in the loan agreement, the lender will take back the car.
Unsecured means you don't put up anything, meaning the risk to the lender is high. You'll pay for this privilege by forking out cash on a higher interest rate.
Personal loans are becoming the go-to solution for people consolidating debt, making home improvements, and financing the unexpected. And while the basics of getting a personal loan may be simple, there are a lot of things about personal loans even the most financially aware among us don't know.
1. You don't need a bank
No getting dressed up and going to a meeting at a branch. The online peer-to-peer finance category is booming, with lenders like Prosper, Lending Club, Peerform, and SoFi competing to loan you money. These lenders handle everything online and offer APRs lower than banks and credit unions. Borrowers with excellent credit and a high monthly income can get rates as low as 4-5%.
2. There are free services to help you make a deal with friends or family
Say you decide to borrow a hefty amount of cash from mom and dad. To prevent misunderstandings and rifts in the family, you can make it legal and official with promissory notes from sites like Rocket Lawyer or LegalZoom. If you're borrowing money to buy a home, the loan must be properly secured in order to take advantage of the mortgage interest deduction. To properly register and manage a home loan with a relative, use a service like NationalFamilyMortgage.com.
3. Someone else can co-sign for you
Is your credit not strong enough to get a loan approved?
Some lenders will accept a co-signer, to secure the loan debt. If a relative or family friend with a longer history and more impressive credit rating agrees to put his or her credit on the line for you, you may be approved for more money than you thought. Wells Fargo & Co. is one private lender that welcomes co-signers on personal loans.
4. You don't have to find a co-signer if you can get people to vouch for you
"Vouching" is like co-signing light. You can ask someone to provide their contact information as a credit reference, which helps to make you look more responsible and like a better candidate for a loan. The credit reference does not make any promise to pay off the loan should you default. He or she is listed to provide information on you, such as your whereabouts, in the event that you stop making payments.
5. Why get a loan when you can get a credit card
If your credit is great and you're able to pay off a loan quickly, you might want to consider treating a credit card with a zero-percent (or otherwise very low) introductory APR as a personal loan. Of course, you'll need to make sure the credit limit is high enough for your needs. You'll also have to be confident you can pay off the loan within a year, or you will get eaten alive by a future high-interest rate when the zero-percent timeline ends. Credit cards are a better choice than a personal loan when your debt consolidation is small, or you want to transfer a balance to another credit card, said David Weliver of the blog Moneyunder30.
6. You can pay an ungodly 35% interest for a personal loan
But that's nothing compared to payday loans. Sure, the interest rates on personal loans start out very low, usually less than 10%. But take a look at the upper limit and you will see you do not want to be there, ever. Borrowers with a high debt-to-income ratio (the amount of debt you have compared to how much money you earn) will often receive a high-interest rate like this. And this is nothing compared to the high rates on payday loans. Depending on where you live, a payday loan can cost you 582% interest! Keep in mind payday loan terms are on average meant to last only two weeks, so if you borrow $500, you will pay $100 interest. This averages out to an annual percentage rate of more than 500%. Sadly, many people don't pay the loans back, meaning they often pay more in interest than the actual loan amount! Beware!
7. You can borrow $5 million with a personal loan
Even though the average amount people borrow is $8,000, according to Citi Bank, personal loans can be obtained for much, much more than that.
A Home Equity Line of Credit, or HELOC, is a form of secured loan that can be taken out in the millions. It works like a credit card, but you're borrowing against the value of your house. The lender will provide you a credit limit depending on your financial status and your credit rating. Wells Fargo offers these small business loans up to $1 million and Bank of America offers them up to $5 million.
To tap the funds, you can simply write a check or use a credit card connected to the account. Your total loan amount cannot exceed your credit limit, but payments are only made on the amount you actually borrow from the bank. These types of loans are commonly used for home renovations. Chase offers HELOCs between $50,000 and $500,000.
8. You can apply for and receive a personal loan the same day
Time is on your side when it comes to personal loans, especially with online lenders. While a typical turnaround time is three days, with all your documents available and no snags, a personal loan from an online lender can be approved within hours. In some cases, you can receive the money the same day.
Otherwise, the wait is not long. It's typically one to two business days.
9. The lowest amount of interest you can get with a lender is about 4.29%
The average is about 7-11% interest on a personal loan, but in certain conditions, you can lock in a much lower rate. SoFi and LendingTree advertise 5.99% rates for borrowers with excellent credit, and when you sign up for auto pay, SoFi's rates drop to 4.29%. It pays to do a lot of research on lenders to compare not only interest rates but also on "origination fees," which are meant to cover the cost of processing the loan and usually equal a small percentage of the amount you are borrowing,
10. Paying back your loan is on you
But be warned. Your balance will not vanish! Just as with student loan debt, if you default on your payments, the lender has a lot of options, such as seizing money in your bank accounts or repossessing your car or another item as collateral. If those tactics fail, private companies will usually sell the loan to collection companies, which can then garnish your wages. Your credit rating will also go into free-fall. It's not advisable in any way to weasel out of repaying your loan.
11. You can ask for more time and better terms
Although your terms are established when you take out a loan, they aren't set in stone. With the right attitude, you can renegotiate your monthly payments, the length of repayment, or both. Getting in touch with a real person is key (visit the bank in person, or if you're having trouble reaching your lender, call another department at the company and asked to be transferred to the lending service (noting the direct line before they transfer you!)), and be prepared to discuss your circumstances and the reason the lender should afford you more time or a better rate. Lenders want their loans repaid, and will not refuse a reasonable offer.
12. You can get a personal loan with no credit
Getting a loan with no credit actually happens. Borrowers with bad credit, little credit, and credit scores in the 600s can be approved for personal loans, although the amounts are usually lower, typically $1,000-$2,500. An average annual percentage rate on a personal loan like this can range from "pretty good" 6-7% all the way to "horrible" 29-35%. If you have a low credit score and want a personal loan, it is especially important to find out if the lender will do a "soft pull" on your credit before offering your rate. This way, your credit rating won't be damaged more in the process.
13. There are scammers trying to get you to take out personal loans
Be careful of unscrupulous lenders looking to scam potential borrowers. Here are a few tips that will help you make sure you're dealing with a legitimate company:
Don't pay upfront fees. Remember that you should never pay anything simply to apply for a loan. If a potential lender demands payment to evaluate your credit history and other financial information, run the other way.
Contact them—not the other way around. If a lender is badgering you, whether through phone calls, mailings, or online, consider that a big red flag. Legitimate lenders of private loans simply don't need to be this aggressive to attract borrowers.
Guarantees are bogus. No legitimate lender can promise that they'll approve your loan application before evaluating your finances. Even payday lenders need proof of income before they'll make a loan.
Verify, verify, verify. Make sure you double-check the lender's physical address, which should be readily available. Also, consider looking them up with the Better Business Bureau or your state banking regulators.
You should feel in control. Take your business elsewhere if a lender threatens you in any way, tries to dissuade you from considering competitors' offers, or tries to get you to borrow more than you owe.
14. You can take out more than one personal loan at a time
It's never a good idea to apply for many loans at the same time because lenders will think you are desperate. But if you're having trouble finding a good interest rate on one large amount of money, you can take out two personal loans in smaller amounts. Be sure to research each lender, and ask if there are any prepayment fees before you sign.
15. People don't even check the interest rate! Or shop around! Or know their credit score
It's true. Some people see the word "apply" online and click the button without having the first bit of knowledge about their financial standing. What's worse is that many lenders do a "hard pull" —a formal credit check by lenders that can temporarily lower your overall credit score—on your credit when you apply for a personal loan, which can knock down your credit rating further. Don't go in blindly. Do your research on different lenders, terms, and how much you want to borrow.
16. Fees can eat up the loan amount
If you need $100, and there is a 3% origination fee, then you'll need to borrow $103. Not all lenders charge an origination fee, but when they do, remember to tack that on to the loan amount.
17. The APR and the interest rate are different
Not many people understand this, but Annual Percentage Rate, or APR, is a more comprehensive rating of how much the loan will cost you. APR takes into account the fees, points, and how much you will pay overall. Percentage rate, on the other hand, is only the percentage of interest the loan will accrue. So while the difference may only be a fraction of a percentage point, the APR is truly a better measure.
18. You wouldn't believe what you can use for collateral
Think beyond a house or a car. Pretty much anything that can be bought or sold can count as collateral. Items that have been used as collateral include:
- interests on box seats at a sports arena
- golf club memberships
- lawn mowers
- suits of armor
- opera tickets
- antique furniture
- art collections
- vinyl record collections
- insurance policies
- medical instruments
- lottery tickets
- wine collections
- tires, and even specialized pumpkin seeds.
That was a lot, but the point is, think outside the box and it never hurts to ask. I once bought a fairly nice watch at a pawn shop, and asked the manager how the watch ended up in the case. The shop had a relationship with a lender who used jewelry as collateral, and the watch was pawned to pay off a loan in default. The manager also had high end handbags, shoes, and a fur coat to sell for the same lender!
19. Personal loans can be used for all kinds of education
Another form of collateral is "future earnings." This is the principle behind all manner of student loans. That is, with more education and training, the earning power of the borrower will be enhanced. However, colleges and universities aren't the only organizations that increase earning power. There are loan issuers who specialize in more specific forms of training, such as truck driving or bartending schools, medical procedures, commercial learning centers, seminars, and even dating services. You may qualify for a short-term loan for this kind of education because you will earn more money in the future.
Even a simple continued learning or continued education course could improve your earnings. When I worked in Nuclear Medicine at a local hospital, the opportunity to take on the role of the Radiation Safety Officer was presented. I had to take certification courses out of state for this, but I increased my salary significantly by taking on the role and getting the proper certifications, all within a few weeks' time, and my employer paid for the certifications.
If you want to learn more about personal loans and how to stop the cycle of expensive revolving debt, then you'll love these articles:
Which of these 19 things did you find the most surprising or unexpected? Let us know in the comments below.