Overview

Personal loans are a handy and easy-to-understand concept. You borrow money from a bank or lender and repay it with a fixed interest rate over a fixed period. Paying a fixed rate means there is less uncertainty to worry about. With credit cards, interest rates can fluctuate, leaving you under a mountain of interest to repay.

When a bank lends you a personal loan, you know exactly how much you’ve borrowed and how much you must pay monthly to repay the debt. Just as with any type of loan or line of credit, personal loans are not by any means “perfect”. However, if you are a responsible borrower, you should have no problem repaying your personal loan.

Before you go out shopping for a personal loan, it’s best to be educated on what a personal loan is and how they work. In this guide, we will go in-depth on how personal loans work, the pros and cons, and also what personal loans can be used for.


How Personal Loans Work

Personal loans are easy to understand compared to other types of loans. You borrow a set amount of money from a bank or lender and repay it with a fixed interest rate. Although the terms can vary from lender to lender, you can find personal loans from $100 and up to $50,000. Some loan terms range from 12 months to decades depending on the amount, the borrower, and the lender.

Just as with any other loan, you will be paying interest and an origination fee. The origination fee is used to pay the loan officer in charge of your loan and to cover the expenses associated with dispersing the loan to you. Depending on your lender and your state, the origination fee usually ranges from 1% to 6%. However, some lenders can charge origination fees of up to 10% in extreme cases.

Thankfully, the personal loan industry is filled with multiple lenders looking to give loans; and Generally, competition has even made some lenders remove all origination fees. Personal loans have higher fees compared to a mortgage or auto loan since it is an unsecured loan. With an auto loan or a mortgage, the lender has an asset to “backup” your loan, in the form of a house or car.

If you defaulted on your loan, the lender could repossess your car or foreclose your home. This is why auto loans and mortgages are considered secured loans. When a lender gives a consumer a personal loan, they are facing a risk of default. If you defaulted on your personal loan, the lender would have no right to take back or repossess any of your property, hence the name “unsecured” loan.


How to Get Qualified

If you have been debating about getting a personal loan, there are a few things you must have to qualify:

Credit: A solid credit score is essential for getting an approval on a personal loan. Although requirements can vary from lender to lender and from state to state, most consumers will need to have a credit score of over 550. The higher your credit score, however, the lower your interest rates will be. If you have bad credit, check out this post on our top proven ways to increase your score.

Cosigner: Having a cosigner is necessary for a personal loan if you have less than perfect credit, essentially, you are borrowing your cosigners credit score in order to help you qualify for the loan. To learn more about cosigners, you can read our in-depth article here.

Ability to Repay: Just as with any other loan, you will have to show the lender your ability to pay them back. This typically means you will need to be able to produce a pay stub from your workplace. If you are self-employed, a 1099 form should be able to do the trick.

Debt Ratios: Most lenders are cautious when it comes to lending money to consumers who already have a large debt burden on their backs. Many lenders will use your debt-to-income ratio to determine if you already have too large of a debt burden. Lenders calculate your debt-to-income ratio by simply taking your monthly debt and dividing it by your monthly income. Ideally, you want your debt-to-income ratio to be roughly 30% or lower. The lower your debt-to-income ratio, the better terms, and rates you will qualify for. If you are still confused on how to calculate your debt to income ratio, check out the example below.

A calculation for debt ratios


Choosing the Best Personal Loan

With so many options available, it’s hard to choose a personal loan that works for you. Before you start searching, find out exactly how much you must borrow. It is also important to know your credit score.

If you haven’t checked your credit score in a while, you can get your free government-mandated report from www.annualcreditreport.com. Legally, the three large credit bureaus are required to give you your credit report for free once per year.

Here are some top tips that can help you find a loan that fits your needs:

Shop: Just as with any large purchase, your goal as a consumer is to pay the least amount of money as possible. Thanks to technology, it’s now easier than ever to find a loan. By shopping online, you can find loans from all types of lenders around the United States.

Reviews: Not all lenders are equal. Some lenders have better customer service, better rates, and provide an overall better experience for borrowers. If you are shopping around for a loan, be sure to read online reviews from consumers who used the same lender. Once you read the experience other consumers had with a specific lender, you can make a much more educated choice.

Go in Depth: When shopping around for a loan, it’s important to understand everything about a specific loan. Lenders try to sway consumers into their loans with some creative and sly tactics. Before you even consider a specific loan, read  the fine print to understand the interest rates, payments, and any fees or penalties that could be associated with your personal loan.


What to Use a Personal Loan For

Personal loans are called personal loans because they can be used for literally almost anything. Below are some of the top reasons consumers take out a personal loan.

Debt Consolidation
If you have debt on multiple credit cards and accounts, a personal loan is a great way to consolidate the debts you have. Consolidating a debt means you combine all your debts into one single payment plan. A personal loan is a great way to help you save on interest. Ideally, you should be searching for a personal loan with a lower interest rate than you are currently paying.

For instance, if you have $10,000 in credit card debt at 8% interest, your goal should be to find a personal loan for $10,000 with a rate that is lower than 8%. When you consolidate your debts, you pay a much smaller interest rate. You can use the proceeds from your personal loan to pay off your remaining debt balance. Now instead of making payments on 8 credit cards per month, you only must repay one single loan at a fixed interest rate.

Medical Emergencies
Medical emergencies are one of the most common uses of personal loans. If you are strapped for cash and need to repay a hospital visit, a personal loan is a great way to do so. Medical expenses are one of the largest burdens on American consumers in history. An emergency hospital visit requiring extensive care could cost you well over $60,000 in as little as a few days.

If you cannot repay your bill, a personal loan can also help you steer clear of going into collections from a medical emergency. However, before you take out a personal loan for a medical emergency, ask your healthcare provider if they have any repayment plans, especially ones with 0% interest.

A New Business
Although it’s best to keep your personal and business finances separate, there are certain situations when it may seem beneficial for you to take out a personal loan for your business. If you have just opened your doors and have had 0 sales or income from the business, you may find it difficult to gain access to a small business loan. If your business is new or is finding it difficult to get a business loan, a personal loan is a great choice!

Credit Score
If you have been struggling to increase your credit score, a personal loan is a great choice. In total, five aspects affect your credit score: payment history, credit utilization, credit history, credit mix, and new credit. A personal loan can be a powerful tool to boost credit scores since it touches on nearly every aspect of your credit score.

If you can make your payments on time and in full, the lender will report that to the credit bureaus. You can even get a small personal loan of just $300 to start with. If you want to avoid getting into debt, you can look at other options such as a secured credit card.

What to use a personal loan for in yellow and blue

 


When You Should Avoid Personal Loans

Although personal loans have helped thousands of Americans in tough financial situations, they might not always be the best option. Sadly, many consumers take out a personal loan they can’t afford. Thus, the account goes into collections and can lead the consumer to credit disaster. Before you take out a personal loan, ask yourself “Can I actually afford to pay for this on time and in full?”.

If your credit score takes a hit due to your missed personal loan payments, you could potentially see a dramatic rise in interest rates. Before you get a personal loan, sit down and budget yourself.

Another time to avoid taking out a personal loan is when it is unnecessary, especially for a large “extra” purchase, such as a flat-screen TV or an RV. If you can live without it right now, then a personal loan should not be viewed as a funding source.

When many consumers get a personal loan in their bank account and see the dramatic rise in their balance, they become euphoric. You could become tempted to finally buy that purse or pair of shoes you’ve been eyeing for months, but it’s best to avoid spending your personal loan money on life luxuries.


Common Loan Scams

As with almost any other industry, there is an endless number of scammers and ripoff artists looking to make a quick buck. While you shop around for the best personal loan, here are some common scams to be aware of:

Loan Insurance
Loan insurance is a bogus item that a fraudulent lender requires you to purchase. Essentially, the loan agent will tell you that the loan insurance is there to cover the loss of the loan if you default. No single reputable lender will offer you loan insurance. Remember, personal loans are an unsecured line of credit, meaning there is no collateral required.

No Credit Check
For lending cold hard cash, every single lender will perform a credit check often referred to as a “hard inquiry”. Advertisements offering personal loans to people with bad or no credit are fake. Never take a personal loan from a company unless they perform a credit check. Although a hard credit check can stay on your credit report for up to 2 years, you at least know your personal loan was legitimate.

Advanced Fees
A fraudulent or fake personal loan lender will often ask that you pay the first few months payments upfront, in order to “reduce risk”. More often than not, they will ask you to pay them via Western Union, MoneyGram, or any other “non-official” payment method that avoids banks and legitimate financial institutions. Not a single lender will ever ask you for payment upfront.

Prepayment Penalties
This can be dependent on the contract you sign with your lender. Sadly, some lenders have prepayment penalties but it’s best to avoid these types of loans and lenders altogether. With a personal loan, prepayment penalties are nearly obsolete.


Final Note

Personal loans are a great tool to have when you need of cash for general spending purposes. A personal loan is a great tool for consolidating debts, getting out of credit card debt, and even paying for medical emergencies. By borrowing responsibly, a personal loan can also give your credit score a massive boost.

If you are looking to get a personal loan, CrediReady can help. Our nationwide network of trusted and verified lenders work with consumers in all credit situations. Take a moment to fill out our free no-obligation loan inquiry form and get the money you need today!