Because of the recession caused by the pandemic, lenders are tightening their lending standards and are being more discerning about who they lend to.
Like them, you should also be wary of new debt—and that doesn’t just mean credit cards, but personal loans as well.
Let’s take a look at the basics of a personal loan, what it takes to get one, and some of the reasons that you might find yourself in the market for one.
How Do Personal Loans Work
A personal loan allows borrowers to obtain money from a financial institution to cover their expenses and later repay them in fixed, monthly installments on a set repayment schedule. “A personal loan is an unsecured loan that provides a borrower with quick access to funds to satisfy a financial need,” says Brad Calhoun, President and CEO of Teachers Federal Credit Union.
Personal loans are typically unsecured, meaning there’s no asset or collateral, like a car or a house, backing the loan. Instead, your terms are based on an assessment of your credit history, credit score, and debt-to-income ratio.
The annual percentage rate, or APR, can vary dramatically depending on your credit, so it’s always a good idea to get multiple quotes through pre-approval. Depending on the amount and your credit, you may not qualify for a good rate — APRs on personal loans can range from 3.49% to as high as 35.99%. (For context, the average credit card interest rate is 14.52%, according to data from the Federal Reserve.)
Personal loans come with fees as well. This can include origination fees (one-time costs that you typically pay when you receive the loan), prepayment fees (charged to you if you pay off the loan early), and late fees (if you ever pay late). So before you apply, make sure to shop around at different lenders to try and avoid these fees — or at least pay as little of them as possible.
Unlike most credit cards, which offer variable rates and open-ended terms, personal loans are often offered at a fixed rate over a specific term that you can request based on your needs. The terms can range anywhere from 6 months to 5 years.
While many brick-and-mortar banks still offer personal loans, you may not need to show up in your local branch to apply for one. Financial institutions have made their way online, often competing with one another to offer the best possible rates, giving consumers more to choose from.
Make sure to apply for the amount that you need and no more. Otherwise, you’ll be stuck paying interest on a larger loan balance.
5 Reasons to get a Personal Loan
Here’s when it might make sense to consider a personal loan:
1. Debt Consolidation
While you can use credit cards to get you through hard times, those interest rates can add up — and before you know it, you’re juggling multiple payments due to multiple banks. “Personal loans can be a great way to consolidate credit card debt at a lower interest rate,” says Kyle Gibbons, a financial advisor with KSGibbons Consulting in New York City. You should consider consolidating credit card debt with a personal loan only if the APR on your personal loan will be lower than your current credit card APRs.
2. Hospital Bills
Medical bills can creep up on you, and if you’re not careful and forget to pay, they could affect your credit. Using a personal loan to pay off those bills could help you deal with charges from unexpected high insurance deductibles and copays. This doesn’t only include visits to the emergency room. Cosmetic surgery, dental work, or even fertility treatments — which may not be covered by insurance and normally need to be paid in advance — can be handled with a personal loan to cover the expense and be repaid monthly.
3. Home Remodeling
Many of us are working from home now, or at least spending a lot more time inside the four walls of our home. So you might be looking around your kitchen and thinking that those cabinets need a refresh. Personal loans are a much lower risk alternative to a home equity line of credit, as they’re not tied to your house, and they may even help you add value to your home. This may help you get that pool, deck, or garage extension you’ve been dreaming of.
4. Car Repairs (But Not a New Car)
The dreaded check-engine light just popped up on your dash and you’re now at the mercy of a mechanic. After learning that your car needs thousands of dollars of repairs, a personal loan could allow you the peace of mind to cover that emergency. When it comes to buying a new car, It may be tempting to go the personal loan route for that as well. But make sure you evaluate your options before jumping in. Terms, rates, and fees tend to be much more favorable when you get a car loan, as your new car becomes the collateral.
5. Unexpected Expenses
Life can throw us all a curveball every now and again, so if you don’t have an emergency fund established, it can be difficult to bounce back from unexpected expenses. Without that safety net or a well-laid financial plan in place, you might find yourself needing some help and a personal loan may provide the quick lump sum needed to stay afloat while the circumstances go back to normal. Just be sure to apply only for the amount you need and can comfortably afford to repay.
What Are the Requirements to Get a Personal Loan?
While every bank, lender, and online lender will have different application requirements based on their own risk tolerance, the process is rather similar. But in general, the interest rate you’re offered will be based on your creditworthiness — and rates tend to be higher than other loan types.
“Interest rates are likely to be higher compared to a car loan or mortgage,” says Lauren Bringle, an accredited financial counselor with Self Financial. “To qualify for a personal loan, especially one with the best interest rates, you need good credit. Lenders also review your income and total debt-to-income ratio to make sure you can repay the money you borrow.”
To apply, you’ll need to provide some personal information, like your full legal name, date of birth, address, citizenship status and Social Security number. Then, you’ll be asked some details about your financials, such as employment status, income, education level, home-ownership status, and the purpose of your loan.
One important consideration, Bringle says, is making sure you have the extra wiggle room to make the payments in your budget. “If you do decide to take out a personal loan, make sure your credit is in shape and you can afford the monthly loan payments in addition to your other bills. Lenders only look at other debts on your credit report when reviewing your ability to repay, and don’t account for other bills like transportation, groceries, daycare, and utilities.”
Whatever your personal situation, weigh your options and make sure a personal loan makes sense for your situation before applying for a personal loan. Here are some of the main reasons people take out personal loans.
Before you start your application, make sure you have the following within easy reach at a minimum:
- Proof of ID — typically a Passport, Driver’s License, or Birth Certificate.
- Proof of Income — such as a paystub, W2, bank statement, or tax returns.
- Proof of Address — like a utility bill, a lease or rental agreement, or a voter registration card.
Good credit and on-time payments history are crucial to getting a personal loan. As with any other type of loan, make sure to evaluate your ability to repay before pulling the trigger. There are plenty of financial institutions that provide personal loans both online and at your local bank branches, so make sure to shop around to get the best rates available to you.