With the coronavirus pandemic wreaking havoc on the US economy and millions continuing to file for unemployment, many people are finding themselves tight on money. Nobody wants to be in this situation, but if you’re strapped for cash, you might consider applying for a personal loan to cover your expenses.
But what exactly is a personal loan? How does it differ from a mortgage or a credit card? Is now a good time to get a personal loan, and what’s the best way to go about it? CNN Underscored has the answers to all your questions about personal loans to help you decide if getting one is right for you.
A personal loan is a type of debt where, typically, a person receives a fixed amount of cash from a bank, credit union or online lender that must be paid back over a set time period, often two to five years.
There are many reasons you might want to get a personal loan. Usually, you can use the money for any reason, but some of the more common scenarios include paying off debt, consolidating medical bills, starting a business, financing a home renovation or other personal needs.
Personal loans are typically — although not always — unsecured, which means you aren’t pledging any assets in advance to cover the loan if you fail to pay it off (also known as “collateral”). This is one way personal loans are different from mortgages; mortgages are instead secured by using your home or property as the collateral.
Because personal loans are unsecured, they’re generally more expensive than secured loans like a mortgage. But while a secured loan comes with a lower interest rate, if you’re unable to repay it, you can lose the asset you’ve put up as collateral, such as your home if you default on your mortgage.
However, even with an unsecured personal loan, if you fail to pay the money back, a lender can still legally pursue you for the amount you owe by sending your loan to a collections agency, reporting your failure to pay to credit bureaus (which hurts your credit score) and even filing a lawsuit in court.
There’s no one-size-fits-all option when it comes to applying for a personal loan. You can look for personal loans at banks, credit unions or from online lenders. There are also online marketplaces such as LendingTree that can make it easy to quickly see offers from a whole network of lenders all at once.
With an online marketplace, you only have to enter your details once to be considered by many lenders. Some of the information you’ll need to provide includes how much money you need, the purpose of the loan, how fast you need the cash and other key details.
Once you’ve entered your information, it’s sent to dozens of lenders for consideration, and you’ll quickly get a list of personal loan offers that may be right for you. From there, you can decide which offers are best for your situation, and work directly with those specific lenders.
Based on data from the Federal Reserve, the average rate for a 24-month personal loan in the second quarter of 2020 was 9.5%. However, personal loan interest rates can vary widely, ranging from anywhere between 6% and 36% depending on the lender, the borrower and the terms of the loan.
Here are the most important factors that determine your interest rate and other costs connected to a personal loan:
Loan Amount: The amount you want to borrow with a personal loan affects your interest rate, as larger personal loans generally come with higher rates. Personal loan amounts can range between $1,000 and $50,000, or even more in some cases.
Length: Interest rates are also usually higher for longer loans, meaning the more time you have to pay off a personal loan, the more you’ll pay for it, both as a result of a higher interest rate and paying interest over a longer period of time.
Credit Score: The higher your credit score, the lower your interest rate on a personal loan. People with good credit scores also have the best chance to qualify for a personal loan, although there are personal loans available for those with lower credit scores as well.
Fees: You’ll want to keep an eye on any fees charged in connection with a personal loan. For instance, some lenders charge an origination fee, which is a fee to start a personal loan. An origination fee can range between 1% and 8%, but some lenders don’t charge origination fees at all, so you’ll want to shop around.
Prepayment Penalty: If your personal loan has a prepayment penalty, you may have to pay an additional fee if you decide at some point to pay off the loan early. A typical prepayment penalty might be several months of interest or a percentage of the remaining loan amount. Again, some lenders don’t charge prepayment penalties on personal loans, so you’ll want to pay close attention to the terms of your loan.
When considering a personal loan, it’s important to know how much you’ll end up paying for it each month. A personal loan payment calculator will help you figure out how much you’ll owe, both monthly and during the overall life of the loan. This is a great tool to use before you apply, so you can visualize what your cost will be from a budgeting standpoint.
Enter the total amount you’re borrowing with a personal loan, the interest rate and the length of your loan, and the calculator will immediately break down your monthly and total payments.
For example, let’s say you’re considering taking out a $10,000 personal loan to pay off your medical debt. One lender offers you an interest rate of 9.5%, which you must pay back within five years, but another lender offers an 8% rate with a three-year repayment period.
You can enter both offers into the personal loan calculator one at a time to see how much each one will cost. The calculator shows that in this case, while a 9.5% interest rate results in a monthly payment of $210, your total repayment would be $12,601. On the other hand, the 8% rate will increase your monthly payment to $313, but you’ll only pay a total of $11,281 over the life of the loan, which is a significant savings.
A personal loan calculator also provides a full amortization table, which breaks down the amount you’re paying for your personal loan in principal versus interest on a monthly basis.
Ultimately, a personal loan payment calculator will do a great deal of the hard work for you in figuring out which loan works best for your specific situation.
If there’s one piece of advice to keep in mind when applying for a personal loan — or any loan for that matter — it’s to strive for excellent credit. This typically means having a credit score of 720 or higher.
With a high score, you’ll be offered some of the lowest interest rates, as well as the most favorable terms. But even if you only have good rather than excellent credit — meaning generally a credit score between 680 and 719 — you’ll still likely be able to get a competitive interest rate on a personal loan.
If you’re right on the edge of having a good credit score, one way to improve your score is to lower your debt-to-income ratio, which is the amount of debt you currently have versus the amount of money you earn. A lower ratio is better, so if you start paying off your debt, there’s a good chance you can increase your score enough to move into the “good” credit range.
Of course, regardless of your score, you’ll still want to do your research on lenders to find a loan with a low interest rate and fair terms. But with a good credit score and a reliable source of income, you should have little problem being approved.
For many, moving up into a good or excellent credit bucket can be very difficult. But don’t let that discourage you. While having a fair credit score — meaning between 640 and 679 — isn’t the ideal place to be, there are still some lenders that will offer you a personal loan.
However, you’ll likely find yourself being offered higher interest rates than if you had good or excellent credit. You may also be subject to fees or less desirable personal loan terms, though these can vary depending on your income and monthly cash flow.
You’ll also probably have fewer personal loan options to choose from with a fair credit score, but this is where an online marketplace can come in handy — since your information can be considered by many different lenders all at once, giving you the best opportunity to find a match.
If you’ve made some poor financial decisions in the past or haven’t yet had time to build up your credit history, your credit score likely reflects this. A credit score under 640 definitely won’t give you the best options when it comes to securing a personal loan, but you might not be completely out of luck.
An online marketplace will submit your information to its lender network even if you have bad credit, and some lenders will still offer you a personal loan. Unfortunately, you’ll almost certainly have to pay a relatively high interest rate if you have a bad credit score. You might even be asked to provide collateral to make the personal loan a secured loan, which could include an asset like your car. That means you’d be subject to losing your collateral if you aren’t able to pay back your loan in the end.
People with bad credit who are considering a personal loan in the future can take advantage of the time right now to start improving your credit score. Some steps you can take include paying your credit card bills on time going forward, making more than the minimum payments on your cards, correcting any errors on your credit report and even negotiating with an existing creditor to accept a partial payment.
These steps aren’t easy, and can take some time and persistence. But in the end, they can make a huge difference in improving your financial future and the likelihood that you can get a personal loan with favorable terms.
Applying for a personal loan truly depends on your situation. If you’re planning to use a personal loan on a non-essential expense — such as a lavish vacation or a big birthday bash — we highly recommend against it. In the end, personal loans are expensive financing options, and you’ll ultimately be paying a lot of extra money for an unnecessary reason.
But if you want to consolidate your existing debt and can get a lower interest rate on a personal loan versus what you’re currently paying on your credit card, then it’s worth considering. You should also look at other options such as a balance transfer credit card or refinancing your mortgage if you’re a homeowner, both of which could offer lower interest rates or better terms than a personal loan.
In the end, personal loans are another tool in your financial toolbox. Given the current economic climate, having cash right now could be worth the cost of a personal loan. So do your homework by knowing what to look for in a personal loan, and find the best offer for you.