When finances are tight, it’s tempting to turn to a personal loan. Borrowers use personal loans for a variety of reasons, including debt consolidation, moving expenses, vacation, and to cover lost income. While personal loans offer flexibility and can provide much-needed relief when things get tight, it’s essential that you thoroughly research your options to avoid finding yourself in a loan with unreasonable terms.
Before you apply for a personal loan, here are a few commonly asked questions that could help you decide if it’s the right fit for your finances:
1. When is a personal loan a good idea?
A personal loan may be a good idea if you can afford to make monthly payments, and you qualify for a fair interest rate. Use online marketplace Credible's free online tools to see what kind of loan interest rate you qualify for.
If possible, avoid lenders who market to people with bad credit or offer loans without a credit check. Many of these companies charge excessive interest rates. The average personal loan rate ranges from 6 percent to 36 percent, but each state has different usury laws that dictate the maximum a lender can charge. Some “bad credit” and payday lenders charge up to 300 percent interest. These rates can make it difficult for borrowers to manage.
2. How much money do I need to borrow?
Before applying for a personal loan, sit down and figure out exactly how much money you need. Aim to borrow only as much as you can afford to pay back. If you plan to take out a personal loan to reconsolidate other debt, your lender may ask for specific numbers, and they may even require that you allow them to send payments directly to your other debt accounts. Some lenders charge loan origination fees, which could increase your total loan amount or reduce the amount of money you receive from the loan.
Credible can help compare personal loan companies (and hopefully land you some of the lowest rates for what you're looking for).
You should also consider using an online personal loan calculator to determine how much money you can afford to borrow.
3. How long do I have to pay back my personal loan?
Your lender will discuss your repayment terms with you. Typically, personal loans have repayment terms between one and five years. Some lenders will allow you to choose your repayment terms. If you want to save the most money, choose a shorter repayment term. However, a longer repayment term will give you smaller monthly payments. Use an online research tool like Credible to compare rates from multiple lenders.
4. How do I get the best interest rate on my personal loan?
If you want to qualify for the best interest rates, there are a few things you can do to help persuade a lender to offer the best terms, including:
- Have a good credit score (aim for at least 650 or above)
- Make on-time payments to your other debts
- Reduce your debt-to-income ratio
- Increase your income
- Offer collateral
- Choose shorter repayment terms
- Research multiple lenders through an online tool, like Credible, to compare rates
5. Will a personal loan affect my credit score?
Personal loans do affect your credit score. When you apply for any loans, the information is included in your credit report and can affect your score. Loan applications add a hard credit inquiry on your credit report. If you have too many queries, your score could go down.
When you receive a loan, the new debt also affects your credit score. A personal loan can positively affect your credit score, however, if you make payments on time or if you use the loan to pay off other debts.
6. Where do I get a personal loan?
Many different types of lenders offer personal loans. Many people prefer working with their local credit union. If you are a member of a credit union, you could benefit from working directly with them for a personal loan. Many credit unions offer lower rates or are more willing to work with customers who are struggling to qualify. You can also work with banks, online lenders, or crowd-funded options.
You can compare rates and see different lending options in one place by using an online tool like Credible.
7. What’s the difference between a secured loan and an unsecured personal loan?
When you take out a personal loan, you could qualify for a secured or unsecured loan. Most personal loans are unsecured, which means the lender gives you money with just your signature. Some loans may require collateral, like a car or a home. These loans are secured because the lender secures your commitment to repay with something you own. If you fail to make payments, the lender can take your collateral
8. What are some alternatives to personal loans?
Personal loans aren’t your only option if you need extra income. Here are a few alternatives:
0% APR credit card: If you’re interested in consolidating your debt or saving money on debt repayment, consider transferring your balances to a 0% APR credit card. If you use an online tool like Credible to compare credit card offers, you could find a credit card with promotions ranging from six to eighteen months of no interest.
Home Equity Loan or Home Equity Line of Credit: Homeowners may be able to tap into their equity and access a lump sum or a line of credit. Your home is used as collateral in these types of loans. While interest rates are slowly starting to rise, you may still be able to get lower-than-normal interest rates.
Peer to peer lending: If you want to avoid banks and credit unions, consider a peer-to-peer lending company. These sites connect people willing to loan money to individuals or businesses.
Personal loans may be an excellent option if you need a little extra cash to get through the next few months, pay for an emergency repair, or consolidate other debt payments. Just remember to do your research, so you find the best match for your needs.