From your vehicle breaking down in the middle of your commute to getting behind on credit card payments, everyone faces financial difficulties at some point. That’s why, in a perfect world, you’d have an emergency fund to cover any unexpected costs. However, 47% of Americans stated they would have to borrow money or sell something to pay even a $400 emergency.
There are many methods to “borrow” money: you may ask a friend or family member for assistance, use a HELOC to borrow against your house if you have adequate equity, or charge the expenditure to your credit card. On the other hand, a personal loan is often safer than a credit card, more widely accessible than a HELOC, and avoids combining love and money.
What Is a Personal Loan and How Does It Work?
Personal loans are short and medium-term loans that are paid back in fixed monthly installments with low-interest rates and borrowed FDIC-insured lenders like credit unions and banks. They are not to be confused with payday loans, which are predatory forms of lending that provide short-term small loans with high-interest rates. They are typically repaid throughout one to seven years (depending on the amount).
“A personal loan is a loan with a fixed rate, fixed duration, and fixed payment,” explains Gary Guthridge, Navy Federal Credit Union’s Assistant Vice President of Consumer Portfolio & Loan Protection Products.
According to PaydayNow (for Bad Credit Loans), Personal loans are generally unsecured, which means you don’t have to put up any collateral in return for the money, and loan amounts may vary from a $250 personal spending loan to $100,000 designated for reliable borrowers wishing to fund large purchases like house improvements.
Some lenders additionally impose an origination fee (often also known as a processing fee) for personal loans, which vary anywhere from 1 percent to 10 percent of the loan amount, based on criteria that include your credit history, repayment plan, and income. The origination fee is typically removed from the loan when paid into your account. It is incorporated into the annual percentage rate (or APR) to represent the total cost of the loan.
When Is It Appropriate to Take Out a Personal Loan?
According to the Federal Reserve, the current average personal loan interest rate is 9.34 percent, much lower than the average credit card APR of 16.43 percent. Rolling outstanding high-interest credit card debt into one unsecured personal loan is a popular option for people with credit card debt because of the low-interest rate.
Although debt consolidation and refinancing are the most specific purposes for personal loans, they may be used for various reasons. For example, the term ‘Wedding Loan’ has been coined to describe personal loans taken out by couples who need to cover the often exorbitant costs of a wedding ceremony but do not have the funds on hand. Homeowners often utilize a personal loan to pay for a home renovation project that will increase the value of their property when they sell it later.
In less happy circumstances, a person may take out a personal loan to cover the cost of unexpected medical expenses if they end up in the emergency room with a high-deductible plan (or no health insurance at all) or to cover the cost of a funeral if a loved one has passed away without life insurance or a large enough estate to cover the cost.
Personal loans may be used for almost anything, but it doesn’t mean you should.
Assume you earn $2,850 a month, which is the median income in the United States. You have about $500 leftover after completing all of your monthly payments (mortgage, electricity, groceries, transportation, and so on). Then one day, when you return home from work, a pipe breaks in your house, causing damage that would cost upwards of $1,500 to repair. While you might theoretically save the money required if you were highly thrifty for the next few months, living in a house with a busted pipe isn’t exactly comfortable. Is a personal loan the correct decision in this instance?
When determining whether or not to apply, you’ll want to do a comprehensive evaluation of your financial condition and the reason you’re contemplating taking out a loan. After all, there are risks associated with any decision to go into debt. While lenders will typically do their risk assessment when you apply, they won’t be able to see everything you can.
Before looking for a personal loan, ask yourself these questions.
What is the stability of my monthly income?
It’s impossible to predict the future, but if you’re going to take out a personal loan of any amount, it’s essential to ensure that your income will most likely not take any significant hits throughout a debt repayment plan. Over a year or two, you may anticipate repaying a smaller personal loan, such as the one required for the broken pipe repairs.
It’s crucial to know that you can’t fast pay your way out of personal loan debt either. Because most lenders want to charge as much interest as possible, they charge borrowers a prepayment penalty if they pay off the loan early, so be sure you can pay back the loan throughout the whole repayment term.
How long would it take me to save enough without taking out a loan to cover the cost? Will I go without the item/repair/event until the money is protected?
Even if you have $500 on hand after paying your monthly obligations, you’ll almost certainly run into some unexpected charges. So, if you can save $300 every month, it will take around five months to pay for the repairs if you don’t have any other issues. You may be able to remain at a relative’s house for a few weeks if a pipe bursts, but waiting five months to fix water damage might lead to other issues like mold, and you’ll likely outstay your welcome at even the most welcoming home.
Some circumstances aren’t as urgent as others. If you and your spouse want to throw a wedding that costs more than $30,000 — the average cost of a wedding in the United States — but only have $7,000 in the bank, it will take a long time to build up enough money to cover the total cost of your dream wedding. If you can’t get go of big-ticket items like a live band or high-end food, at the very least, postponing your wedding date may help you save money and reduce the amount of a loan.
Is it possible for me to borrow money from friends or family and pay it back over time?
It’s not easy to ask for financial aid from your loved ones. If you have someone ready to pay the cost of repairs, it may be a better option to turn to them before taking out a loan from a financial organization. If anyone can help you, you can avoid taking out a larger loan.
Will the cost of debt outweigh the benefits?
When making financial decisions, it’s an age-old question to ask yourself: What will be the return on investment?
In certain circumstances, the answer is accompanied by a monetary value. Minor bathroom upgrades, such as retiling, replacing the vanity and tub, and changing fixtures, have an average return of slightly over 70%, making it a wise long-term investment even if it involves taking on a short debt. In other cases, the returns are determined by your particular choices and levels of satisfaction. Although not everyone wants a large wedding, the pleasure of being accompanied by all of your friends and family on your special day may exceed the cost of going into debt.
Fixing a broken pipe won’t add any new value to your property. Still, the hardship of waiting for months on end, maybe having to pay for accommodation on top of mortgage payments, or extra difficulties from the damage might be more expensive than the loan itself.
Have I explored all of my other options?
When everything is said and done, if you’re out of options, you’re out of alternatives. If you can reasonably make monthly payments on a loan for the foreseeable future and it’s something that must be done, then a personal loan is your best choice.
What is the Best Place to Get a Personal Loan?
So you’ve decided to get a personal loan. So, what’s next? The first and most crucial step is to do some research.
Personal loans are provided by internet lenders, banks, and credit unions, all of which have their own set of advantages and disadvantages. It’s critical to study the small print on each available choice and search for hidden fees or penalties, as well as the estimated payments and interest rate.
“I advise people to deal with reputable banking institutions. That way, you’ll know exactly what you’re getting into before you even start the loan,” Guthridge explains.
Lenders on the Internet
You may generally get accepted for and receive a personal loan in as little as one business day after applying with an online lender like Rocket Loans or SoFi. Pre-approval for loans from internet lenders is very prevalent, which means you can obtain fast rate quotations and know your rate and loan duration. One of the most significant benefits of being pre-approved is that lenders will only run a mild credit check during this time, so shopping around won’t damage your credit score. You may then choose which choice is appropriate for your financial circumstances and complete a thorough application.
On the downside, although internet lenders often provide some of the lowest interest rates, these deals are typically reserved for persons with near-perfect credit ratings and payback histories. Plus, although internet lenders may provide loans to those with lower credit scores at higher interest rates, you may get in over your head without somebody to walk you through the process if you have a negative credit score and a less-than-perfect repayment history.
Banks with a long history
If you pursue the usual extensive bank method, borrowers have certain limitations. If you follow the standard comprehensive bank method, borrowers have certain restrictions. Not all large banks provide personal loans from them. Most conventional banks also primarily loans like Discover or Wells Fargo, mainly giving debt consolidation loans. Big banks require a minimum score of 700.
If you do happen to be a devoted member of a bank that provides the personal loan type you require — even local brick and mortar banks, there are rewards available that other lenders can’t give. Banks frequently save their best bargains for long-term clients, such as reduced interest rates and discounts.
Credit unions are a kind of cooperative financial institution.
Your credit union is likely to give you adequate safeguards, rates, flexible terms, and customer service when it comes to personal loans. According to Guthridge, credit unions may also provide smaller loans than internet lenders and central banks, with Navy Federal offering personal spending loans beginning at only $250.
Credit unions can provide such comprehensive benefits to members because they are not-for-profit, which means that, unlike banks, which are accountable to wealthy shareholders, every member of a credit union is a shareholder with equal rights.
The disadvantage of borrowing from a credit union is that they don’t always have the same high-tech options as big lenders, so approval and receipt of the loan may take a few days longer. To qualify, you must also be a member (i.e., have a checking or savings account with the organization).
Can You Get a Personal Loan With a Bad Credit Score?
If you’re in the process of rebuilding your credit score, it might be distressing to learn that many prominent lenders have minimum credit score criteria. However, just because you have a bad credit score doesn’t mean you can’t get a loan. If your credit score is below 600, you have three significant possibilities, depending on the circumstances.
1. Be willing to accept a higher APR.
You can see what annual percentage rates you qualify for once you’ve been pre-approved for loans from major online lenders. Reputable lenders seldom offer personal loans with more than 36 percent APR. If paying such a high-interest rate is still a viable option for you, this is one option.
2. Enlist the help of a co-signer.
The borrower faces a minimal risk when applying for a loan with a co-signer, whereas the co-signer faces significant risk. While the borrower is still responsible for repaying the loan, if they fall behind or cease making payments, the co-signer becomes responsible for fulfilling the loan’s requirements. If you have an honest and trusted connection with someone in your life, such as a spouse or parent, and they are ready to assist, this is an excellent choice for you.
3. Get in touch with your local bank or credit union.
When you’re a devoted member or client of a credit union or a local bank, you get several benefits, including better possibilities for borrowers with terrible credit. In cases where significant banks and internet lenders wouldn’t, smaller, more private institutions with whom you have a history may be more likely to listen to you and come to an agreement on loan conditions.
How to Make an Application for a Personal Loan
The next step is to fill out the application once you’ve done your homework and figured out as best you can what your interest rate and repayment plan will be.
The procedure is quite similar to applying for a credit card, whether you walk into a bank or credit union or fill out an application online. You’ll need evidence of identification, such as a driver’s license or passport, proof of residence, such as a copy of your lease agreement or a utility bill, and proof of income, such as a copy of your pay stub or tax returns.
After that, the lender will go over your information and look for red flags. They will also do a rigorous credit check on you, which is why you should get a free credit report ahead of time to guarantee that you are eligible for the loan.
“We normally look at a person’s credit scores, debt-to-income ratio, and all of their other debts, such as credit cards or vehicle loans,” Guthridge explains.
How a Personal Loan Pays Out
When your application has been approved and your loan details have been verified, the first thing you should do is automate monthly payments.
“It’s strongly advised that payments be made directly from a person’s checking account,” Guthridge explains. You’ll never have to worry about skipping a payment again, and you’ll be able to include the deposit into your budget right now.
The funds you’ve requested will be put into the account you choose. When it comes to debt consolidation, lenders may send money immediately to credit card issuers and collectors, but most of the time, the funds will be in your hands first. You then must use the funds towards why you had sought out the loan in the first place.