6 Things to Know About Personal Loans
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When money is tight and you’re in a pinch, quick financing in the form of a personal loan can save the day. They’re also ideal for consolidating high-interest debt and ultimately putting you on the right track to pay off your balances; reducing your interest rate frees up more money you can direct toward the principal.
- Personal loans are usually unsecured
- Personal loans typically have fixed interest rates
- Some personal loans have fees
- Repayment terms vary
- You may be able to borrow more than you think
- Personal loans have many uses
1. Personal loans are usually unsecured
Don’t let the name fool you: personal loans go far beyond a personal friend or family member lending you cash. Many online lenders, credit unions and banks offer these types of loans to creditworthy borrowers who are able to demonstrate a solid credit history. A good credit score is critical because personal loans are typically unsecured.
“What that means, essentially, is that there’s not an asset available for the loan, like a car, house or account you’ve pledged to cover it,” David Metzger, a Chicago-based certified financial planner and founder of Onyx Wealth Management, told LendingTree. “A credit card is probably the most extreme version of an unsecured loan.”
But while credit cards are lines of credit that you can charge up and pay off as you go, personal loans are lump-sum installment loans. The money is given to you in one chunk and can even be deposited directly into your bank account after a relatively quick application process. From there, you pay it back via fixed monthly payments.
Again, since the lender has no asset to seize should you default on your payments, interest rates generally trend higher than secured loans, like a mortgage or auto loan. Still, they’re often lower than credit cards. Average credit card APRs are currently 16.5%, according to the Federal Reserve. For the sake of comparison, check out these lenders:
2. Personal loans typically have fixed interest rates
Interest rates for personal loans vary, depending on your credit score, but they currently range anywhere from 3.34% to 35.99% as of the date of publishing. The good news is that nine times out of 10, personal loans come with fixed interest rates. In other words, this rate will remain the same over the life of the loan. This takes the headache out of budgeting because you know what you’re getting into right from the get-go; no surprises.
Variable-rate loans, by contrast, typically start out with a lower rate, then fluctuate to reflect current market conditions. When rates are trending low, the math could actually work out in your favor, but rates have been on an upward swing for some time now. Lucky for borrowers, fixed-rate personal loans are unaffected by rate hikes.
3. Some personal loans have fees
Qualifying for a personal loan with a reasonable interest rate is the first step, but be sure to read the fine print before making any decisions. Some lenders tack on origination fees or prepayment penalties, warns Metzger. The first is a fee for processing your loan. These days, this typically ranges anywhere from 0% to 8%, depending on the lender.
A prepayment penalty will hit you if you wipe out the balance ahead of schedule. This is when a lender penalizes you for paying your loan off early. It’s sort of like being sent to detention for turning in your homework before it’s due, but rest easy knowing that not all lenders do this. The most important thing is to read over the loan terms carefully before signing on the dotted line.
4. Repayment terms vary
No two personal loans are alike. As such, loan terms vary widely. When shopping around and comparing quotes, the repayment timeline is definitely worth your attention. Why? It can significantly impact how much you end up paying in the long run. A shorter loan term typically works out to a larger monthly payment, but you’ll pay less in overall interest.
Take a look at how differently a $6,000 personal loan with a 9% interest rate shakes out when you condense the repayment timeline.
|$6,000 personal loan with a 9% interest rate|
|Repayment timeline||Monthly payment||Total interest paid|
In addition to the repayment timeline, you’ll also want to zero in on APRs when comparing personal loan quotes. APRs go a step further than just the interest rate, factoring in additional fees as well. A higher APR works out to a more expensive loan. It’s essentially how much you’re paying to borrow the money.
5. You may be able to borrow more than you think
Now for some brighter news: Those with excellent credit and a steady job can usually unlock a good amount of (quick) cash with a personal loan. Borrowing limits, like loan terms, vary quite a bit, but anywhere from $1,000 to $50,000 is possible. Again, your borrowing power relies on a number of factors.
If your credit score is one side of the coin, your income is the other. Metzger says lenders evaluate all your debts and compare the total to your earnings. The lower your debt-to-income ratio, the better the terms will be.
6. Personal loans have many uses
Personal loans can pretty much be used for whatever you like, but that doesn’t mean they’re always a good idea. Taking out $5,000 for a last-minute vacation could end up costing you twice as much after accounting for interest.
“If you’re taking out a loan just to subsidize your lifestyle, then that’s a terrible idea,” said Metzger.
There are some situations, however, when a personal loan makes a lot of sense. The first is if you find yourself in some sort of financial emergency—a surprise medical bill, a stretch of unemployment, a pricey car repair you weren’t expecting. If you don’t have enough cash savings to cover it, a personal loan is certainly cheaper than reaching for a high-interest credit card.
Speaking of high-interest debt, Metzger also sees value in using a personal loan to consolidate debt, assuming you don’t charge up new debt afterwards.
“Debt consolidation loans can be a solid, disciplined and scheduled way of paying off debt you already have, but you’ve got to be cognizant of why you got into debt in the first place so you’re not just freeing up space on your credit cards to charge them up again,” he said.
This debt payoff strategy involves taking out a personal loan that has a lower interest rate than what you’re currently paying on your other debt. You use the lump-sum loan amount to pay off your balances, after which you’ll only be responsible for the new loan payments. Crunch the numbers here to see how much you can save with this easy hack.
When times get tough, a personal loan can be the thing that saves you from financial disaster. They can also save you thousands if you’re currently trapped in a high-interest debt cycle. Just keep in mind that this type of loan is unsecured, so interest rates are generally higher than loans that are collateralized by an asset like a home or a car. There are definitely competitive rates out there, though, especially for borrowers with great credit and steady income.
Metzger says your best defense is crafting a realistic budget that allows you to gradually squirrel money away into your savings account—this way, you’ll be prepared for your next financial emergency.