How Personal Loans Work
Whether you want to consolidate credit card debt, finance home repairs, or pay for a wedding, personal loans can be a great way to meet your financial needs. Most personal loans are unsecured loans, which means they don’t require collateral. Since eligibility is based on several factors like your credit history and debt-to-income ratio, each loan’s terms will vary from situation to situation. No matter your circumstances, it’s important to familiarize yourself with the details before applying for a personal loan.
What Are Personal Loans?
Designed to help you fill the gaps in your financial situation, personal loans can be a resource if you need cash. Interest rates are often lower than credit cards and payday loans. Plus, unlike some types of loans, personal loans allow you to use the funds for nearly any purpose.
Because personal loans are usually unsecured, rates depend on your creditworthiness rather than what you have for collateral. But how do you get the best loan rate possible? And can you get a loan without perfect credit? Personal lending has become highly customized, and many lenders tailor loans to a variety of situations. Let’s take a closer look at personal loans so you can take the next steps without any lingering questions.
Pros and Cons of Personal Loans
How Can You Use Personal Loans?
Personal loans are versatile and can be used for many purposes, including:
If mounting credit card debt or loan payments have you in a little over your head, you’re not alone. In fact, debt consolidation is one of the most common reasons people get personal loans. It can be an effective way to get a lower interest rate and go from multiple monthly payments to a single payment.
Personal loans don’t require your home as collateral, so they can be an appealing option for financing home improvements. Of course, home equity loans and cash-out refinance loans are other options to consider. Depending on your situation, a personal loan could be the right option.
Every so often, emergency expenses can’t be avoided. For instance, you never know when an unexpected auto repair or medical bill will pop up. Since personal are so flexible, they can be used for a variety of purposes. So, a personal loan may be useful for surprise bills.
Weddings can be expensive. In fact, the average cost of a wedding was $19,000 in 2020. And that cost is expected to climb this year. Fortunately, personal loans are an option. From floral arrangements to venues, a personal loan can help finance upfront costs as you plan your dream wedding.
Have you been feeling the urge to hit the water? Recreational boat financing is another popular reason folks get personal loans. Whether you’re considering a used boat, yacht, or anything in between, a personal loan could be useful. And if your credit isn’t exactly perfect, you may be able to get a secured personal loan that uses the boat as collateral.
If You’re In Debt, You Aren’t Alone
Struggling with debt is more common than you might think, and you’re certainly not alone. In fact, the average American is more than $90,000 in debt. With high credit card interest rates and multiple payments, even the smallest debt can easily grow. As you can see in the table below, American adults of all ages have debt to pay off.
Average Debt by Generation
What Factors Affect Personal Loan APRs?
Several factors impact personal loan APRs, including your:
- Credit score: The higher your credit score, the lower your interest rate is likely to be. Although it’s not impossible to get a personal loan with a lower credit score, a co-signer may be required.
- Debt-to-income ratio: Many lenders look for a debt-to-income ratio (DTI) of 36% or less. A DTI under 20% is considered low, and a DTI of 43% is often the high end of what a borrower can have and still get a loan.
- Employment history and income: Your employment record and expendable income may affect your APR. Lenders may expect at least one year with your current employer before approving a loan.
- Loan term: Before you sign on the dotted line, make sure the loan term is affordable. Generally speaking, loans with longer terms will have slightly higher interest rates.
Can You Get a Personal Loan With Bad Credit?
Creditworthiness is determined by examining both your credit score and your employment history. Having a credit score on the lower end of the spectrum doesn’t necessarily disqualify you from receiving a loan. However, those with higher credit scores tend to reap the benefits of lower personal loan rates. If you don’t qualify for a personal loan on your own, then you may be able to get one with a co-signer. Additionally, a co-signer may help you qualify for a lower interest rate.
What’s Considered a Good Credit Score?
Frequently Asked Questions
Do personal loans require collateral?
The majority of personal loans are unsecured loans. So, that means they don’t require collateral. Each lending institution will have its own set of requirements, but personal loans are typically based on your creditworthiness.
What documents do you need to apply for a loan?
When you apply for a personal loan, you’ll need to provide several documents. Personal loan lenders typically like to see your identification, proof of income, tax returns, and credit history. However, it can vary from lender to lender.
What are common personal loan fees?
In addition to paying interest on your loan, there are several fees you may need to cover. Not all personal loan companies charge an application fee, but many apply origination fees. Other fees can include a penalty for early payoff and charges related to late payments.
Are there alternatives to personal loans?
While personal loans can be a useful way to access cash, they aren’t the only option. For example, alternatives include home equity loans and cash-out refinance loans. Of course, personal loans come with certain advantages; chiefly, they generally don’t require collateral.
Can you get a personal loan with a co-signer?
If you have a lower credit score or a short credit history, a co-signer can be a good way to secure a personal loan. Co-signers use their good credit history as an insurance policy, but your loan will also show up on their credit report. So, entering into a co-signer agreement should never be taken lightly.
Too Long, Didn’t Read?
Whether you want to apply for a personal loan to consolidate debt or finance big expenses, it can be a useful way to access cash fast. Of course, there are a few things to keep in mind to get the best online personal loan. In order to set yourself up for future financial success, it’s a good idea to figure out how much you need and only take out that much. You’ll also want to take into account the monthly payment schedule and budget accordingly.
Getting the lowest interest rate depends on several factors, including the credit history you’ve built and your debt-to-income ratio. Personal loans are different from many other types of loans. But the more you know about personal loans, the more prepared you’ll be to negotiate the best repayment terms.