Personal Loans Guide

When you need money quickly, personal loans are a great way to get cash in hand. You can apply and get approval quickly, even with bad credit, and the repayment terms are typically more favorable than credit cards. But personal loans have some downsides as well. Before you decide if a personal loan is the right option for you, it’s important to understand how these loans work and how you can make them work for you.

Advantage of Personal Loans

Personal loans have several advantages, especially for those working toward debt consolidation or improving their budget. Personal loans allow you to borrow money with lots of flexibility and with a set, structured repayment schedule. This creates a lot of opportunities for good financial habits.

You Can Consolidate Debt

Debt consolidation is the top reason for a new personal loan. High balances on credit cards can make for a complicated repayment plan. If you’re trying to pay off debt on your credit cards, you may not get very far thanks to the way the credit card APR is calculated. The minimum monthly payment on a credit card is not enough to pay down the card in a timely fashion, especially if you are still charging new purchases with the card.

With personal loans, however, you can take out one loan for the total sum of your credit card debt. Then you pay off the credit cards and eliminate the individual payments for those cards from your monthly budget. You make a single payment instead of the new monthly payment schedule on the personal loan and you’ll have the debt cleared out in no time.

Consolidating other, higher interest, loans through a personal loan allows families to get back ahead financially when they have too much debt. Lowering the amount a family spends every month on debt, may be enough to break the paycheck to paycheck cycle and allow greater financial health, especially if the family is able to start saving for a financial safety net or emergency fund.

No Collateral Is Needed

While a personal loan makes regular, typically set, payments on a regular basis much like a car loan, a personal loan does not require collateral. It is an unsecured loan. The rate and terms of your personal loan are based almost entirely on your credit score and your debt-to-income ratio. If you have an excellent credit score, you will have one of the lowest APRs available on these types of loans.

If your FICO score is poor, you may still qualify, but you can expect to pay more in interest. A fair credit score would land you a rate somewhere in the middle. Personal loans average interest rates between 10 and 28%. In many cases this rate is lower than you would pay to borrow money through a credit card cash advance.

Personal Loans Have Flexible Uses

A mortgage is only used on a home. A car loan is only useful for a vehicle. A personal loan, however, can be used for anything. The loans are unsecured by an asset, and the funds can be used in a variety of ways. Individuals take out personal loans for debt consolidation. They can use loans to purchase boats, campers, ATVs, and other large items. Personal loans are also used frequently for home renovation.

While you may be asked why you are borrowing funds in the preapproval process for a personal loan, ultimately, the funds are yours to use as you please once they arrive in your bank account. Of course, using the funds for something other than intended purpose would likely not help you financially.

Personal Loans Are Readily Available

Finally, there are many ways to get personal loans. They are offered by traditional banks, credit unions, peer lenders, and online lenders. Thanks to the many lender options, personal loans have become the fastest growing segment of the personal debt market. This creates a great opportunity to build credit and helps to improve your chances of approval.

If you have excellent credit, you may be notified that you can prequalify at your traditional brick and mortar bank. Traditional banks tend to have the most stringent criteria for loan approval. If you didn’t get approved at your traditional bank (and 38% of those seeking personal loans are turned down at least once [1]), you have many other options.

Credit unions tend to be a bit more flexible than traditional banks. Peer to peer lenders are even more flexible, and online lenders have the most options, especially for borrowers with poor to fair credit or a high debt-to-income rate. Just do your research to be sure you’re working with a credible lender. There are many personal loan scams out there that would love to take advantage of would-be borrowers.

Personal Loan FAQ

Do I need good credit to apply for a personal loan?

There are personal loans available for almost every level of credit. A good credit score will be awarded a lower interest rate, while those with poor credit will wind up paying more for a loan with a higher APR.

How quickly can I get money from a personal loan?

It depends on your lender. Some lenders are able to move very quickly, and have you funds within a day or two. Others take a bit more time for the approval process and then to transfer funds to your bank.

Can I take out more than one personal loan?

Yes. Since you can apply for personal loans through different lenders, you can take out as many personal loans as you can be approved for. Just be aware that all of those loans will likely have origination fees and they will definitely have monthly payments that start immediately. Don’t open more loans than you can afford to pay back.

What happens if I don’t pay the loan back?

If you are struggling to repay a personal loan, contact the lender. You may be able to change the repayment terms. But if you fail to make the required payments, your loan will go into default. This will be reported to the credit bureaus, and your credit score will be badly damaged. Some lenders may choose to sue you for the repayment as well.

How much does it cost to apply for the personal loan?

Most applications for personal loans do not have an added cost. There may be loan origination costs once approved for the funds, but the actual application tends to be free.

Disadvantages of Personal Loans

While personal loans seem like a great idea for several reasons, they aren’t always as beneficial as someone might hope. As of 2019, there are more households defaulting on personal loans than credit cards, mortgages or student loans. It stands to reason that personal loans may not be an ideal solution to every household problem.

Personal Loans Can Be Expensive

While it’s possible that the APR on a personal loan might be less than you’d be paying by carrying a balance on your credit cards, that is not always the case. If your credit cards have special offers for zero interest on balance transfers or new purchases, any personal loan will be more expensive than paying off the balance of the card at zero percent.

Personal loans can have other costs as well. Many personal loans include origination fees, which is the cost of taking out the loan in the first place. Loans that don’t have these fees may charge a bit more in interest. There may also be a prepayment penalty on a personal loan, just like some mortgage and car loans. In these cases, you must pay an additional fee if you pay off a personal loan early.

It’s worth noting, however, that you have the option of refinancing a personal loan. If you took on a higher interest or more expensive personal loan when your credit was bad or you had a thin credit file, you can improve the terms of that loan once you’ve had a chance to boost your credit score.

Opening a New Personal Loan Affects Your Credit

It’s important to know how personal loans affect your credit score. Your FICO, or credit, score is a combination of different things weighted at different percentages. Some financial factors, like your credit utilization ratio, is weighted heavily. At the same time, other areas, like recent hard inquiries to check your credit score by lenders, are given far less weight.

When you have maxed out credit cards, you are using all of your revolving credit, so you have a high credit utilization ratio. A personal loan is not a revolving line of credit, however, so it is not counted toward this credit score factor. By paying off your high-balance credit cards or other lines of credit with a personal loan, you will actually improve your credit score by improving that key factor.

On the downside, however, by opening a new account, presumably after many hard and soft inquiries on your credit, you are going to see a dip on three other factors. One, the inquiries will be reported and will remain on your credit for six months, bringing your FICO score down a bit. Two, you will have a newly opened account, which will potentially increase the amount of debt you owe, hurting that key factor.

Finally, a brand-new personal loan account will shorten the average lifespan of your credit. That will also cause some negative impact on your overall credit score. You can mitigate this issue a bit, however, by leaving your zero balance credit card open after you pay it off. Since you’ve had the cards longer than the loan, they will help balance the new account. That zero balance card also helps tremendously to improve your credit utilization rate.

Not sure how a new personal loan affected your credit? Use one of the many financial and budgeting apps to monitor your credit regularly. You can see how your new loan impacts your score and watch for any credit report error as well.

Missing Payments Can Harm Your Credit

Personal loans are not tied to collateral. They are also easy to get, even with less than a credit score of 700. This makes personal loans ripe for potential loan mistakes. If you make a mistake and take out a personal loan you can’t afford, you can wind up doing significant harm to your finances.

Missed payments, defaulted loans and other money mistakes are reported to the credit bureaus and can bring your credit score down significantly. If you use your personal loan to consolidate credit, be sure to hide or destroy the credit cards you’ve paid down. Charging the credit cards back up is one of the worst loan mistakes you can make. Once the cards have a balance again, you will effectively have twice the payments – the personal loan payment and the card payments.