In a NutshellA personal loan can be a great way to fund large expenses or save money on higher interest debt. However, there are things you should know before applying for a loan to make sure you secure the best one for your needs.
Whether you’re looking to consolidate debt, finish a home improvement project or fund a medical emergency, you may need additional funds.
While it’s better to cover the need through personal savings if you have them, personal loans are also a possible solution.
What is a personal loan?
Personal loans can cover a wide variety of financial needs. Todd Nelson, business development manager for personal loan provider LightStream, says, “Many lenders offer loans for personal, household or family purposes, like credit card consolidation, auto purchases or home improvements.”
What separates unsecured personal loans from other loans is that most other loans (like mortgages or auto loans) classify as secured loans that are protected by collateral (something like a car or a house, which your lender can take if you can’t pay back the loan).
Some personal loans are secured — for example, Wells Fargo offers personal loans that are tied to your savings account. However, most personal loans are unsecured which means if you default, the lender is on the hook for the money they’ve loaned to you. As a result, lenders typically will charge higher interest rates for unsecured loans than secured loans, Nelson says.
Where can I get a personal loan?
Prior to The Great Recession, going to a brick-and-mortar bank was the only real option for those needing personal loans. That isn’t the case today. Common providers of personal loans include:
- Banks. Banks aren’t the easiest place to get a personal loan, but their safety and convenience make them an ideal first stop if you have an established relationship with one.
- Credit unions. Credit unions aren’t all that different from banks, but unlike banks, they’re member-driven and not-for-profit. Because of this, credit unions are often able to offer lower rates than banks, so you may want to include them in your search.
- Peer to peer (P2P) lending. P2P lending is the newest option on the block. They offer online options for loans that may be helpful even if you don’t qualify for them through more traditional routes. However, like banks and credit unions, P2P lending sites will assess your credit history and score, and may review other factors including your current job and your level of education before approving you for a loan.
Banks and credit unions look closely at your credit history and score to determine the amount they’re willing to lend to you. Peer-to-peer websites, in most cases, allow you to borrow anywhere from $1,000 to $35,000.
Regardless of who you choose to go with, consider limiting the number of loan applications you submit, as too many can negatively impact your credit score.
This is because whenever you apply for a loan, the lender will most likely check your credit report in order to make their decision. This is known as a hard inquiry and it may lower your credit score by a few points. They may also remain on your report for two years.
There are other alternatives to personal loans, like payday and car title loans. However, experts generally recommend avoiding these options as they typically have exorbitant interest rates and fees. For example, according to the Consumer Financial Protection Bureau, a typical two-week payday loan may have fees that equate to an APR of almost 400 percent.
Getting a personal loan when your credit needs work
Getting a personal loan with credit that needs work is possible, though often more difficult — and more expensive. Banks and P2P lenders generally evaluate your credit history and current situation when making a lending decision, so if your credit score isn’t great, it may result in a higher interest rate.
Also, if you have credit that needs work, consider getting a co-signer. Nelson says, “You may not be able to receive a personal loan unless you have someone with good credit co-sign with you, making them responsible for the debt as well.”
Getting a co-signer shouldn’t be taken lightly because if you default on the loan repayments, the co-signer is now responsible for repayment. That said, it may be worth considering if you’re facing challenges securing a loan through other channels.
A personal loan can be a great way to fund large expenses or save money on higher interest debt. However, make sure to do your homework before applying for a loan to secure the best one for your needs.