Let’s face it: there are some things we all should have been taught about in school but weren’t: managing your account balances, basic budgeting, and how to take out and use loans come to mind. That last skill is essential, as personal loans can be an excellent way to build credit and help you achieve your financial goals. Below, we go into everything you need to know (and then some!) about taking out and using personal loans. Welcome to Personal Loans 101!
What Are Some Reasons to Get a Personal Loan?
One of the most common reasons why people get a personal loan is to consolidate their debt. Essentially, you take out the loan and use it to pay off your other high interest debts such as credit cards or other loans. Once all of your other debts are paid off, you now have just the one affordable monthly payment and don’t have to worry about keeping everything straight!
One of the biggest pros of using a personal loan to pay down your debt is lower interest rates. Especially if your debts come saddled with high interest rates or APRs, a debt consolidation loan with a lower rate can reduce the overall interest you pay as well as the time it takes to pay off your debt.
Life has a funny way of throwing us a curveball when we least expect – or need – it. If you’ve suddenly found yourself dealing with an unexpected situation, like the passing of a loved one, a medical emergency, or even unemployment, a personal loan can be a great tool for covering those costs and helping you keep your financial life stable during a rocky time.
If you’ve ever undertaken a home improvement project, you know that there are hidden expenses everywhere. Even something as seemingly simple as painting your living room a new color or fixing a leaky faucet can cost an arm and a leg! That’s why a personal loan can be great for completing necessary repairs or upgrading your home. Unlike taking out a home equity line of credit, a personal loan doesn’t require you to use your house as collateral. This takes away the additional stress of having your home on the line and lets you focus on transforming your house into your dream home.
Did you know the average cost of a wedding in 2021 was $22,500 (Source)? For couples who want to throw the wedding of their dreams but don’t have that kind of funds on hand, a personal loan can help them cover the costs upfront without having to touch their savings or retirement.
What Are the Pros and Cons?
Flexibility and versatility
Personal loans don’t pigeonhole you into using them for one specific purpose. You can use your funds for anything you’d like!
Lower interest rates and higher borrowing limits
Unlike credit cards, personal loans typically have both lower interest rates and higher borrowing limits, meaning you can receive more while paying less.
Easier to manage
As we talked about earlier, personal loans can be used to consolidate multiple debts into a single, fixed-rate monthly payment. This frees up the time and energy you were spending to juggle several debts, and can even save you money in the long run.
Fees and penalties can be high
Some personal loans come with different penalties and fees that increase the cost of borrowing. Things like origination fees or prepayment fees can be so high that they actually increase your debt load.
Higher monthly payments than credit cards
One of the advantages of credit cards is the flexible minimum monthly payments they offer. Personal loans come with a fixed monthly payment where there isn’t a minimum amount option.
Additionally, credit cards have no deadline for paying off your balance in full, while personal loans require you to pay them off by the end of the loan term.
Can increase debt
Used correctly, a personal loan can be a great strategy for reducing your debt. However, personal loans don’t address the root cause of that debt. Paying off your credit cards with a loan, for example, frees up your available credit limit. Those who struggle with overspending may find themselves once again racking up charges rather than capitalizing on their fresh start.
How do I Apply for a Personal Loan?
“Okay,” you might be thinking, “A personal loan sounds right for me…but where do I even begin?” Luckily, taking out a personal loan is more straightforward than you think!
Crunch the numbers
Prior to going into the loan application process, you’ll want to know these three numbers: how much cash you’ll need, the estimated monthly payment you can afford, and your credit score.
The first number is relatively easy to decide on, as you’re going to want enough to cover the cost of whatever you’re using the loan for. If you’re using it to consolidate debt, you’ll want to add up all the debts that you’re going to be paying off with the loan. Keep in mind that some lenders do charge what’s called an origination fee. This one-time fee is deducted from the total amount of the loan, differs depending on the size of your loan, and will lower the actual amount that you get, so be sure to factor in an origination fee of around $300-$500 into your overall loan amount.
Monthly payment estimate
The next part involves a bit more math on your part, but we promise it’ll be worth it in the long run! You’ll want to take a look at your budget and see what kind of monthly payment will be manageable. Make sure you think about all your core expenses (such as utilities, rent/mortgage payments, bills, transportation costs, subscriptions, etc.) as well as your more variable costs, like meals out at restaurants, movie tickets, or clothing. After all, you shouldn’t have to cut all the fun out of your life to pay off a loan!
Once you have this number in mind, it’s time to look at your credit score. Most lenders will use this number to determine the loan offers and terms you get, so it’s important to be aware of it. You can get a full copy of your credit report for free from AnnualCreditReport.com and can monitor your credit score using apps like Experian. Once you have your full report, go over it with a fine-toothed comb to see if there are any errors. If you discover any mistakes, you’ll want to contact Equifax, Experian, and TransUnion (the 3 major credit reporting agencies) to get them corrected. After you’ve ensured there are no errors, move on to the next step of the application process!
Weigh your options
While it’s true that the best personal loans typically require a credit score above 670, there are other ways of ensuring that you get a good rate. One way is to get a co-signer for your loan. Your co-signer should be someone who has good to excellent credit, has a stable income, and who you trust completely. If your co-signer meets these requirements, then the lender receives additional reassurance that your loan will be repaid, and you receive a better interest rate!
You’ll also want to weigh where you plan on looking for a personal loan. Traditional banks are much less flexible in who they lend to but may offer lower interest rates or better terms to those who do qualify. On the other hand, online lenders, such as Credit Direct, are often more willing to work with those who have lower credit.
Don’t sign on the dotted line right away
Finding a personal loan is like casual dating: even if the first person (or loan) you meet is great, you should still go out with other people just to be sure. For personal loans, this means that you should do your research and compare the rates and terms you’re seeing with one another. Some online lenders will even let you get prequalified and see your rates without damaging your credit score, making it even easier to decide what’s right for you! Lenders that don’t offer prequalification will usually run a hard credit check as a part of the application process. A hard check or inquiry can lower your credit score, so it’s best to do your comparison shopping within a 30-45 day period. This will reflect as a single inquiry on your credit report rather than multiple checks that lower your credit each time.
Pick the right fit for you and apply
So, you’ve found the personal loan that seems to be the best fit? Great! Now comes the application process. Depending on the lender you choose, you may be able to complete your application online or may have to apply in person at your local credit union branch or bank. Each lender is different in terms of what information they’ll ask for. Still, it’s standard to ask for your name, address, contact information, employment information, income, and the reason you’re applying for your loan. Make sure you’re taking the time to review the terms and conditions of the loan agreement. This will help you avoid hidden fees, repayment clauses, and other potential pitfalls.
Congratulations, you’ve completed Personal Loan Basics 101! Hopefully, you’ve learned all you need to know about personal loans and know if one is right for you. But if you still need a bit of tutoring, our loan agents are here to help! They can walk you through applying, explain your rates, and so much more. And as a bonus, with Credit Direct you could get approved as soon as today! Check your rate in minutes with no effect to credit score.