Thousands of people take out personal loans daily for various reasons. Even so, personal loans are not for everyone. There are multiple factors to consider before taking out a personal loan.
From emergencies to individual purchases, personal loans are an excellent option when you don’t have enough cash on hand for a specific occasion. Each personal loan application is unique, so you must be well-versed in applying.
Your credit history, interest rates, fees, and ability to repay the loan in the future are also things to consider. We’ll break down all of these considerations and more today.
Personal loans are built for people who need a certain amount of money on one particular occasion. These personal loans are repaid over a set amount of time, which is why they are also called installment loans.
Even though it should be looked at on a case-by-case basis, you should only get a personal loan if you really need the money. Taking out a loan without thinking things through could hurt your finances in the long run. Think carefully about your situation before making a decision.
People may take out personal loans for a wide array of reasons. Some of the most common reasons are listed below.
People with limited or no health insurance may need a personal loan to pay for unexpected medical costs. These can also include medical expenses not covered by insurance, such as fertility treatments.
Health and well-being should always come first, so if you need a personal loan to get the health care you need today, consider getting one.
Housing and transportation are on the list of needs for our daily lives. If the water heater breaks in winter or a storm damages the side of your home, you will need repairs fast. The same goes for a broken-down vehicle on which you and your family rely.
You may lack the emergency fund necessary to deal with these repairs, or perhaps your fund doesn’t cover the total cost. In this case, getting a personal loan to help pay for the repairs would be best.
Certain bigger purchases, like large home appliances, cannot wait. Others, like that beach vacation, may be better off postponing it for a few more months.
There are different types of personal loans, each with its own set of requirements set by lenders. Generally, all personal loans require a government ID to verify your identity and age.
Proof of income or other documents about your current financial situation may be part of the other paperwork you need. These typically include pay stubs, W-2 forms, salary letters, or tax returns.
Not all loans are created equal. Below, we will list the most common personal loan types and their specifications.
Unsecured personal loans are the most common type of loan. For this loan type, no collateral is required.
While this makes it easier for you, the borrower, to access the loan, it also makes it more difficult for the lender to have a guarantee that you will repay it. If you fail to make the monthly payments, the lender does not have any physical assets to seize from you.
Because of this, unsecured personal loan lenders look for reliability when it comes to the borrowers they approve. A good credit score, usually at least in the high 600s, is needed to get an unsecured personal loan.
Since it is seen as a riskier loan on the lender’s part, you’ll have to ensure you can and will repay the loan. If you don't make the payments on an unsecured personal loan, it could hurt your credit score in a big way.
Secured personal loans are the other side of unsecured loans. They require collateral for approval. This collateral could be one of many assets in your possession, such as your vehicle, savings account, or even a certificate of deposit (CD).
With these loans, you don't need as good of credit as unsecured ones, so more people can get them. This means all you need is an asset.
Secured personal loans need collateral to protect the lender if you don't repay the loan monthly. For example, if you were to fail to make a repayment and had placed your vehicle as collateral, your car would be repossessed by the lender.
Since this collateral offers less risk for the lender, the borrower benefits from lower interest rates on secured personal loans than unsecured ones.
These loans are not as common as fixed-rate or unsecured personal loans but can be found with certain lenders. Also called variable or float-rate loans, adjustable-rate loans have interest rates that vary over time.
While this sounds unappealing at first, these loans typically start with a very low rate, attracting borrowers. Depending on how the market is doing, these rates can go up or down, which changes the monthly payment.
This type of loan works best for those who know they can repay it quickly, avoiding extra months of unpredictable payment amounts.
Interest rates play a large role in determining which personal loans are most popular. Most personal loans are fixed-rate, which means that the interest and monthly payments are consistent throughout your repayment.
This makes it easier for you to plan how much you can pay each month, which helps you pay off your loan quickly and on time. Furthermore, it also allows you to calculate your interest over the loan’s life, leaving little room for unpleasant surprises.
Your credit history and/or credit score are a reflection of your total debt, lines of credit, and payment history. Think of it as your financial transcript, given to higher financial institutions to accept or deny your access to things like loans and financial accounts.
The better your credit, the more lender options you can choose from. This allows you to find lower interest rates, potentially saving you thousands of dollars. Better credit also opens the door to more personal loan options, such as unsecured personal loans.
It’s important to remember that your credit history affects not only your personal loan but vice versa. Paying back your personal loan is essential to maintaining or even raising your current credit score, and future lenders will be able to see if and how you repay this loan on your credit history.
If your credit score is good or excellent, happy personal loan hunting! If it’s below average, we recommend working on it to better your financial future. You can improve your credit score by paying your current dues on time and limiting your use of credit cards.
One of the biggest factors to consider before taking out a personal loan is the interest rate the lender offers. Interest rates are essentially the fee you’re paying on what you owe. They are included in your monthly payments and vary depending on the loan and amount.
Small differences in interest rates make big differences in how much you will pay by the end of your loan.
Take this example: A personal loan of $25,000 over five years at 6% interest will have you paying around $4,000 in interest by the end of your loan. That same loan and timeframe with a 6% interest rate will charge you around $5,400 in interest. That’s over a $1000 difference per one percent interest rate.
These numbers could be much higher depending on the amount and time frame of the personal loan. Before you agree to the personal loan, use a free loan interest calculator to determine how much you will have to pay in interest. Only take it out if you can afford the repayments, interest included.
The interest rate and your loan repayment are not the only charges your lender may include in your personal loan. Look out for and ask about things like a processing fee completed while applying for certain loans. Some of these are non-refundable, even if you are denied the loan, so make sure to read the fine print.
Another possible fee is the prepayment fee. This is incurred when a borrower chooses to pay off the loan before the agreed-upon date.
Finally, there are also late payment fees, which are only incurred if you fail to make your monthly payment by the due date.
Before getting a personal loan, you should also consider how you will repay it.
First, take a look at all of your current monthly bills and accumulated debt. Calculate the income you have left over at the end of the month. This will determine your maximum possible monthly payment to repay a personal loan in the future.
Ensure this limit doesn’t leave you with a balance of $0, as other emergencies may always arise. Account for possible changes in your income, such as unpaid holidays or vacation days.
Once you know how much you can afford to pay back per month, determine how long you are willing to do so. Repaying a loan affects both your credit score and your overall financial health.
Do you expect any other future expenses that may get in the way of your monthly payments? Have you accounted for accrued interest and fees? Remember that some personal loans charge a fee if you plan to repay the loan early.
Set your boundaries and only take out a personal loan that respects them.
Perhaps you hope to work on your credit history and do not need to take out a personal loan at this time. While taking out a personal loan is always an option, there are other alternatives in the meantime.
If the situation is not urgent, saving money is the safest way to make a purchase. This avoids taking on more debt, thus not negatively affecting your credit score. You’ll be able to focus on your current bills and move forward with a financial goal in mind.
To do this, ensure you have a budget and stick to it. The final purchase will be much sweeter when you pay for it with cash in hand.
A credit card may be a good alternative if you need to make a smaller purchase and don’t have the money upfront. While interest rates are higher than personal loans, you can pay back this smaller amount faster during your next billing cycle with fewer fees. There’s more flexibility than personal loans, but the borrower should be wary of accumulating too much credit card debt.
Payday loans abound for those with low credit scores or dismal credit histories. These are quick ways to get cash in hand with typically easy application processes.
While it may seem appealing, payday loans often come with high-soaring fees, which can leave people trapped in repayment. Make sure to inquire about all fees and total costs before considering a payday loan.
There are many factors to consider before taking out a personal loan. First, it’s important to decide if the reasons for your loans are urgent and necessary or if they can wait. If the emergency warrants the loan, you’ll have to understand which loans are available and which you qualify for.
Once you narrow down the type of personal loan you would like, it’s time to compare lenders, paying special attention to interest rates and fees. Lastly, don't forget to put paying back your loan at the top of your list if you want to avoid having money problems in the future.
A personal loan is a great way to face financial emergencies when you need cash fast. When used responsibly, they can be a lifesaving force in the face of a financial storm.