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Known for their flexibility, personal loans can be taken for a number of reasons — managing unwieldy credit card debt, paying for an expensive roof replacement, and so forth.
Unlike credit cards or home equity lines of credit, you take out a loan with a fixed amount and have to pay it back with fixed monthly payments at a fixed interest rate. That rate can vary widely between 5 and 36%, depending on your creditworthiness.
In general, the better your credit score and credit history, the lower your rate. But in 2020, banks have raised their lending requirements even higher — making it even more difficult for people with bad credit or a limited credit history to get a loan.
Why Is It Harder to Get a Personal Loan?
Lenders use your income, employment status, credit history, and credit score to determine the likelihood of you paying back the loan — or defaulting on it. That risk is reflected in your interest rate. If you have no debt and a history of paying your bills on time, then you have access to better rates. Conversely, if you have no credit history or have had trouble with debt, your rate will likely be on the higher side, or you may not qualify for the loan at all.
Anuj Nayar, financial health officer at LendingClub, suggests comparing rates when considering the trade-off of a personal loan versus a credit card. “Any [personal loan interest] rate that is lower than the rate you’re paying on your credit card is better than what you’re doing right now,” he says. (Borrowers also need to account for other up-front costs of personal loans, such as origination fees.) The average credit card interest rate is about 16% right now, and it typically ranges from 14 to 26%.
Even if you were laid off recently, you have significant credit card debt, you’ve filed for bankruptcy in the past, or your credit score is below 600, there are options available that could make you a more attractive candidate to the lender — namely, secured loans and cosigners.
However, keep in mind that many lenders have tightened lending qualifications in light of the pandemic and its negative impact on the economy. LendingClub, for example, has refocused efforts on existing customers and upped the verification standards for income and employment. The pool of prospective personal loan applicants has gotten bigger at the same time the economy has contracted, resulting in a tough climate for would-be borrowers.
Secured loans require a form of collateral, often a major asset, to be approved for a loan. Collateral can be your home, bank accounts, or investment accounts, or your car, depending on the lender requirements. This will require more paperwork and more risk on your end, because if you default on the loan, the lender can take possession of that collateral.
The trade-off is the lender will feel more comfortable extending an offer and may give a better rate than if the loan were unsecured. Most loans are unsecured, which come with faster approval times but typically higher interest rates and more stringent credit requirements.
These types of loans may take longer to process, as it requires the lender to verify that you own the assets put up as collateral. In the case of a house or real estate, an updated appraisal may be required to determine the equity value of the collateral.
If you don’t own major assets, or at least none that you’d want to put up as collateral, then getting a cosigner is an option. A cosigner is a secondary borrower with a good credit history that can allow you to qualify for the personal loan, which you would be responsible for repaying. Cosigners may boost your odds of loan approval and likelihood of getting a lower rate because more information is given to the lender, who may be loath to give money to a person with no credit history or poor credit history.
Cosigners don’t have a right to the money from the loan and don’t have visibility into payment history. However, they would be on the hook for the loan if the borrower cannot, or does not, make payments. That’s one reason why it’s important to figure out your loan payment plan before applying for a loan. If you are not confident you can pay back the loan, then you and your cosigner will take a credit score hit.
Alternatives to Personal Loans
What if you can’t get a personal loan, or the interest rate you’re offered is too high to be worth it? There are more options on the market besides personal loans, such as peer-to-peer loans, small business loans, and paycheck advances. Here are two common alternatives to personal loans: credit cards with promotional rates and HELOCs. We find these two are the most accessible to the average borrower, though these options, like personal loans, do favor candidates with good credit scores.
Credit cards with promotional rates
Many credit cards will offer a 0% introductory APR period on purchases and balance transfers for 12 to 15 months. Provided you make at least the minimum payments on time, you won’t be charged interest for the whole time period, after which the interest rate will revert to the regular purchase or balance transfer APR, which will likely range from 14 to 26% depending on your creditworthiness. You may also need to pay a percentage on any balance you transfer, likely between 3 and 5%.
If the math works out in your favor, these credit cards are helpful for transferring debt from high-interest cards and saving interest.
The credit limits tend to be reasonable too. “If you are looking for something to bridge you for the next six months, the credit lines on these cards can be around $10,000 to start,” says Farnoosh Torabi, finance journalist and host of the “So Money” podcast. “If you can pay [the balance] off within that time frame, that’s a great alternative.”
However, it’s important to be mindful of any limits on these promotional rates, as some cards will charge you interest retroactively if you haven’t paid off the balance by the end of the introductory period. As in all situations, we recommend reading the fine print before opening a credit card.
If you own a home, you may be able to tap into the value of your home with a home equity line of credit (or HELOC). Torabi compares a HELOC to a “big credit card limit,” in that it’s a revolving credit line where you can borrow as much or as little as you need, and it isn’t a loan. Like loans, though, HELOCs can be used to fund large expenses or consolidate other forms of debt.
The interest rates — usually variable — tend to be lower than credit cards, ranging from 3 to 20%. However, Torabi recommends caution around a HELOC, as the collateral is your home. There’s also the fact that major banks, such as Bank of America and Wells Fargo, have tightened lending standards around HELOCs amid the COVID-19 pandemic.
“Right now, banks are not being as generous with HELOCs because they know that if you go bankrupt or if you can’t make your payments, you’re going to more than likely default on your HELOC and your primary mortgage. So they have very high standards for who can borrow against their homes,” Torabi says.
Ultimately, you’ll have to weigh the risk yourself and see if the low interest rates and flexible line of credit would afford you the ability to make payments on time.
How to Improve Your Credit
Do you see yourself applying for a loan down the line? Whether or not you might need to apply for a loan in the future, or pursue loan alternatives, basic credit health is always worth keeping in mind. Here are some ways you can up your credit score and become a better candidate to lenders.
Make payments on time
One of the main factors of your credit is your payment history. Do you pay your credit card on time and in full? Do you at least make the monthly minimum payments? In the lender’s mind, a spotty payment history translates to a risky borrower.
If you have difficulty with paying bills or loans, we recommend contacting your creditors and asking for some sort of accommodation — deferred payments, a lower interest rate, some way of relaxing requirements. Many major banks, credit unions, credit card companies, and loan providers have responded to COVID-19 with financial relief programs to help you if you’re experiencing hardship. A formal accommodation from your creditor will also help your credit history because your payment status will read as current, even if a payment has been waived for a month.
Keep credit cards open
Credit scores take into account how long you’ve owned a credit card, so think twice before closing credit cards. Even if you switch to a better credit card, consider keeping the old one open and paying occasional payments to establish a history of responsibility. A scattered history with credit cards can hinder you and lower your credit score.
Request a higher credit limit
The major credit scoring companies (FICO, VantageScore) rely heavily on “credit utilization,” or the amount of available credit used, as a factor for your credit score. The lower the ratio, the better — meaning, $500 balance reflects better on a credit card with a $10,000 limit than a $5,000 balance (50% utilization rate). Experts generally recommend using under 30% of your available credit at any time.
Review your credit reports
Due to the COVID-19 pandemic, you can now get free weekly credit reports through April 2021 from the major three credit bureaus (Equifax, Experian, and TransUnion) at AnnualCreditReport.com. In your credit report, you’ll see payment history for every loan or credit card you’ve taken out, as well as rent and bill payments if you’ve opted in with your creditor. Look through the report for any discrepancies or inaccuracies. You have the right to dispute any errors and get them removed.