There are various reasons why you could need a personal loan, as we shall see.
Unlike other types of loans, a personal loan is an unsecured loan, which means the funds you borrow are not secured by a high-value asset that you own.
Instead, you simply receive a lump sum of money and agree to pay it back in installments over a predetermined period of time with prearranged conditions.
You would typically make repayments on a monthly basis. With each payment, you will have to pay interest.
Before you decide to take out a personal loan, you should first check out the following ultimate guide, in which you’ll learn when to use a personal loan, what features to look for, and more.
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When should you use a personal loan?
There are various borrowing options available, such as getting a secured loan, which is used for a specific purpose like buying a car, and getting a credit card. But if you don’t want to put up assets as collateral or if you don’t qualify for a credit card or if your credit card limit doesn’t meet your borrowing needs, getting a personal loan is probably your best option.
Personal loans usually need to be paid back over fairly short periods of time. Typically, personal loans run from 12 to 60 months.
Here are some of the instances when you should consider taking out a personal loan.
To Tie You Over
If you know that you have a lump sum owed to you in the near future but don’t have enough cash in the meantime, it could make sense to get a personal loan to bridge the gap.
To Finance Home Improvements
Many people take out personal loans to pay for home improvements, like an extension, a new furnace, or a new garage.
If you have equity built up in your home, you could always opt for a home equity loan or home-equity line of credit instead, but with such options, you’ll be putting your home on the line, so it could be better to go with an unsecured loan like a personal loan.
To Pay for a Key Life Event
Because a personal loan is often less expensive than other borrowing options, the loan can be a great way of paying for major life events, such as paying for an event like a milestone anniversary celebration or your child’s university fees.
Though, as an aside, you could save on university fees if your kid decides to study using an online platform instead.
To Consolidate Credit Card Debt
If you owe a substantial amount on one or more of your credit cards and those cards have high-interest rates, you could save money by taking out a personal loan.
For instance, you could pay the balance down more quickly, allowing you to pay less overall.
Also, by using a personal loan to consolidate credit card debt, it will be easier to pay off a single debt obligation instead of paying off multiple credit card debts.
To Improve Your Credit Score
If you want to improve your credit score, in some circumstances, getting a personal loan could enable you to do that.
For instance, if your credit report mostly shows credit card debt, adding a personal loan could help your credit mix.
Basically, by having different types of loans and using them in a responsible way, you can better your credit score.
What should you look for in a personal loan?
Different lenders provide different features, so you could get a better deal with one lender compared to another.
The key thing is to find a personal loan that’s right for your specific circumstances.
Here are some of the things you’ll want to look for in a personal loan.
Low-Interest Rates
The interest you pay on your personal loan can soon add up, but by shopping around, you can compare different interest rates and find the right option for you.
Look for a lender that offers low-interest rates, but make sure you consider the other following factors rather than simply going for the lender with the lowest rate.
No Fees
Following on from the last section, there could be no point in getting a low-interest rate if the lender charges exorbitant fees.
Some lenders charge origination fees, which are typically between 1% and 10% of the loan amount.
The origination fee is usually deducted from the loan before you actually access the money but it could also be included in your monthly repayments.
You don’t get anything in return for an origination fee. It simply refers to the amount the lender charges for processing the loan.
The good news is a few lenders don’t charge any fees.
For example, SoFi personal loans have a no-fee policy. Furthermore, SoFi offers low rates and makes the process of getting a personal loan simple.
Fast Funding
Personal loans are often taken out for urgent expenses, such as a roof repair. If you’re looking to take out a personal loan for an urgent expense, or you simply want the cash to take a long-overdue vacation, thankfully, personal loans are often given out very quickly.
You can often secure a personal loan in under one week.
So, when considering which loan to take out, look at how fast you can obtain the funds after your application has been approved.
Payment Flexibility
Different lenders have different requirements concerning the period over which personal loans must be paid back, so look for a lender that can provide you with a repayment schedule that’s right for your circumstances.
You may want to pay back your loan within a year or two. Alternatively, you may prefer a longer loan period of, say, four or five years.
A Lender That Has Glowing Reviews
One more thing to look for in a personal loan relates to the lender itself. You’ll want to make sure you choose a reputable lender that people recommend. So, research any lender you’re considering going with before you take out your loan.
You can perform simple research online by looking at customer feedback and reviews. The more glowing reviews a lender has, the more certain you can be sure that it’s the right option for you.
What do you need to do to apply for a personal loan?
Once you decide that a personal loan is the right option for you, it’s time to apply for a loan. But before you do so, you’ll need to consider things like how much you can afford to borrow and how long you want the repayment period to be. You’ll also need to check your eligibility.
By knowing such things in advance, you can ensure the application process runs smoothly.
Here are the key steps you need to take when applying for a personal loan.
Calculate How Much You Want to Borrow
The first step is to work out how much you want to borrow.
Even if you qualify for a larger amount, you should only borrow the amount you actually need. If you do go with a larger amount because it sounds tempting and you could always do with a bit of extra cash, bear in mind that you’ll end up paying a lot more interest in the long term.
Not only do you need to calculate how much you need to borrow. You also need to calculate how much you can afford to repay each month.
Armed with that knowledge, you can figure out how long you’ll need the loan for.
You can use an online personal loan calculator to figure out what your monthly repayments would be over differing timeframes.
Check Your Credit Report
You should find out what your credit score is before you apply for a personal loan.
The reason is prospective lenders will run credit checks so they can determine whether you’re in good financial standing and can therefore be approved for the loan.
You can get a free credit report from the three leading consumer reporting companies, which are Equifax, TransUnion, and Experian, once per year.
You can request a copy through sites like AnnualCreditReport. You could also use Credit Karma to track your credit score.
Once you obtain your credit report, you could find your credit rating is less than ideal. If that’s the case, you should take steps to improve your credit score before you apply for a personal loan. You can then ensure that you’re likely to qualify for the loan.
Ways of improving your credit score include paying bills on time, reducing your debt, and not taking on any more debt.
Gather Documents
By gathering all the documentation you’ll need to apply for a personal loan ahead of time, you can speed up and simplify the loan application process.
You’ll need to provide the lender with proof of your identity. So, make sure you have an acceptable form of identification, such as a driving license or passport.
You’ll also need to show proof of your address. A utility bill that is less than three months old is ideal for proving your address.
You could also need documentation that proves you have the right to work in the country as well as proof of your yearly income.
Submit Your Loan Application
The final step is to submit your application. The lender you choose to go with will give you information on the precise steps you need to take.
Most lenders enable you to make applications for a personal loan online.
During the application process, you will have to give information like your personal details, such as your name, address, and details of your employment, as well as details of your main financial outgoings, such as mortgage costs and bills. You could also have to provide information about how much you spend on existing credit repayments.
You will then need to state how much you want to borrow, how long you want the repayment period to be, and what your reason is for borrowing.
Answers to Questions
We have already covered a lot, but you could still have some questions about personal loans that we have not yet answered. So, here are the answers to some of the most popularly-asked questions.
How does a lender determine how much you can borrow?
We already mentioned that lenders will look at your credit report to determine how much you are eligible to borrow, but other factors can affect the amount too.
Collateral, such as your house or car, can play a large part in how much a lender will offer.
Whether you have an existing relationship with the lender can also play a part in how much you’re able to borrow.
Are personal loan interest rates fixed or variable?
Interest rates on personal loans can significantly vary, based on things like your level of income and credit score. Of course, interest rates can also vary greatly from one lender to another.
The majority of personal loans are made at fixed interest rates. However, variable rates are starting to become more common for personal loans.
Are personal loans subject to tax?
Because a personal loan isn’t counted as income, it’s not subject to federal income tax. And, unlike mortgage loans, the interest on personal loans is not tax-deductible.
The only time a personal loan could be subject to federal income tax is when the loan is partially or completely forgiven or discharged as part of a debt restructuring or personal bankruptcy.
Can you pay off a personal loan early?
Whether you can pay off a personal loan early or not simply depends on the specific lender you go with.
Sometimes, early repayments are possible but always check with your lender before you sign on the dotted line of your contract. And if an early option is available, you could have to pay a penalty fee.
Are you able to know why an application has been denied?
In the United States, you have the right under federal law to know why a personal loan application has been denied.
If your application is denied, you can therefore find out the reasons why and take appropriate steps to secure another loan. For instance, you could go with another lender or you could work on improving your credit score before you apply again.
Alternatives to Personal Loans
If you’re still not sure if a personal loan is the right option for you, consider the other options you have available. Then weigh up those options alongside the personal loan route to determine what the best solution is for your particular circumstances. Options include the following.
A Credit Card
One easy credit option is to get a credit card.
If you’re not aware, credit cards work on the so-called revolving credit system. That means you’re given a credit limit and you can borrow anything up to that limit on the credit card at any one time.
Once you reach your limit, you won’t be able to spend more on the card until you have paid some of the balance off.
Credit cards can be great for managing money and accessing extra cash when you need it, but generally, if you’re looking for funds for something major like a home extension, an option like a personal loan will usually be a better choice.
Hire Purchase
If you want your personal loan to buy a car, you could consider a hire purchase instead of a personal loan.
Hire purchase is usually arranged through the retailer. It can be used for other products besides cars, but it’s most commonly used for purchasing vehicles.
It works like this: you pay an initial deposit, which is typically 10% of the overall cost of the product you’re buying, and you then pay off the remainder, with interest, via monthly installments over an agreed period of time.
Summing Up
If you want money for a major expense, like a vacation or home renovation, a personal loan is one of the best options available.
You can also use personal loans to tie you over while you await a payment, pay for a key life event, such as funding university or a special anniversary celebration, or to consolidate credit card debt or improve your credit score.
When searching for a personal loan, you should look for low-interest rates, no fees, fast funding, and flexible payments. You should also research any lender you’re considering going with by looking at online customer reviews.
Once you’re ready to apply for a loan, make sure you’re prepared by calculating how much you want to borrow, checking your credit report, and gathering the right documentation.
Also, make sure you get answers to any outstanding questions you have before you sign on the dotted line.
Personal loans can be incredibly handy at certain times in life, so if you need some extra cash for something important, you should certainly consider the personal loan option to gain the funds you need.
