Kalicia Bateman is a personal and education finance writer at BestCompany.com. Through research and collaboration with other industry experts, she is committed to helping consumers make positive financial decisions.
At one point or another you may need some extra money to make things work - finishing up your home renovations, paying for that big vacation, or paying off unexpected medical expenses. Whatever the reason may be, taking out a personal loan may be a great way to meet those large and/or unexpected expenses that may come up, and there is no shame in borrowing money when needed!
What is a Personal Loan?
A personal loan is a large sum of money borrowed from a lender, whether that be a private online company, a bank, or a credit union. Designed to be paid back over an extended period of time, personal loans are most often used for larger purchases of expenses that would be more difficult to pay back with another borrowing method like a credit card. However, in any borrowing arrangement you not only agree to pay back all borrowed money, but you also agree to pay the lender for the risk of lending to you in the first place, which is known as interest.
Interest is the cost of borrowing money. As a calculated percentage of the loan, interest is usually quoted as an annual rate also known as the annual percentage rate (APR). For a personal loan, interest will be included in your monthly payments. There is, unfortunately, no way to dodge paying interest. But depending on your credit score, you can get lower rates, which could lower your monthly payments and save you some money overall.
Generally, personal loans are installment loans, meaning that you will make monthly payments for an agreed period of time, known as the term, or life, of the loan. You can either receive fixed or variable interest rates, which will affect how much your monthly payments will be. A fixed rate means that your interest rate will never change throughout the life of the loan, whereas a variable rate is dependent on the market, which can fluctuate. Therefore, with a fixed rate your monthly payments will always be the same, but with a variable rate monthly payments may vary.
One of the most important things to remember about personal loans is the importance of making on-time payments every single month - No matter how much money you borrow, or how long you have to pay the money back, you should always stay on top of your payments. If you miss or are late on payments, you could get hit with late fees, but it can also have a negative impact on your credit score.
Now that you have a better idea of what a personal loan is, you may be wondering what it takes to qualify for a personal loan. Surely if you are borrowing large amounts of money there would be some specific requirements that borrowers should meet, right?
What Does it Take to Get a Personal Loan?
When you are looking into taking out a personal loan, it is good to know what lenders are looking for when you apply. Most often, lenders look at your credit score, your debt-to-income ratio, and that you have a verified source of income.
While having a low debt-to-income ratio and a verified source of income are very important for ensuring that you can pay back your loan, your credit score may be the most important factor. Most lenders will have a minimum credit score requirement for potential borrowers, which will vary lender to lender. The reason why they have this is because a high credit score indicates to the lender that you are “less of a risk”, as your credit score is calculated by your past payment behavior (whether that be credit card payments, or other miscellaneous payments that have been reported to one of the “big three” credit bureaus: Experian, Equifax, and TransUnion). An excellent credit score can also get you more competitive rates and terms. The national interest rate average is approximately 9.41%, but with good to excellent credit you should expect a lower rate, potentially around 6%. It is important to note that interest rates can be as high as 36% for personal loans.
If you have bad credit, or no credit, some lenders may offer a cosigner option. A cosigner is someone with really good credit that applies for the loan with you. Their credit score is taken into consideration, which could improve your chances of approval and getting the best rates possible. However, securing a cosigner can be tricky because they are taking a risk because they will also be held responsible for the payment of your loan: if you can’t make payments, the cosigner will be responsible for making them. Therefore, if you would like to apply for a loan with a cosigner, consider asking a family member or a close friend, as they are people that know and trust you.
Overall, if you don’t meet these requirements, there is a chance that your loan application could be rejected, and that’s definitely not the desired outcome.
Are There Other Options Besides a Personal Loan?
Maybe all of this personal loan business isn’t sounding like the best option for you and your financial needs. Have no fear, there are some other borrowing options that you can consider:
Credit Cards - Credit cards are ideal for smaller, every day purchases and are a common means of borrowing money and building credit. It is important to consider the differences between credit cards and personal loans, because although they are similar at face value, some purchases will be better supported by one versus the other.
Personal line of credit - A personal line of credit is very similar to a credit card, but instead of a physical, plastic card, it is a loan received from a bank. The loaned money can be used for any purpose, but you can’t exceed your credit line.
Peer-to-peer loan - A peer-to-peer loan is similar to a personal loan, but instead of borrowing money from a financial institution, you borrow money directly from an individual instead.
These are, by no means, the only alternative options available to you, but they are some other popular ways to borrow money when needed.
Should I Get a Personal Loan?
The question of whether or not you should get a personal loan is entirely based on your own financial needs and circumstances. It is important to consider what you need the money for, what your current credit score is, and if you are in a position to make consistent on-time payments.
Finding the best personal loan for you will likely take research and patience, and it’s important to recognize that there are multiple options and lenders available, allowing you to find the best personal loan for you!