What should you know before taking out a personal loan?

What should you know before taking out a personal loan?
June 14, 2022 | Lois Sullivan

Taking out a personal loan can help you consolidate debt, pay for an unforeseen expense, start a home improvement project, or even build a new business.   However, before applying for any personal loan, you should check that the lender doesn’t impose any restrictions for business use. Personal loans are convenient for many people, and they can offer low rates for those with good credit scores. Here's some more information about how personal loans work, the benefits of personal loans, and how to get one.

How personal loans work

Personal loans can come with a variety of interest rates and other terms.

A personal loan is a type of installment loan with a set term and amount. Borrowers get their money in a lump sum, and they must make regular payments. These loans don't work as revolving lines of credit such as credit cards, so if you need more money than you planned, you'll need to apply for another loan.

Secured vs. unsecured loans

Personal loans are usually unsecured, meaning you don't need collateral, like a house or a car, to qualify. A secured loan is secured by collateral. People agree that the lender can take the collateral if they stop making payments on the loan and default. For example, the collateral for an auto or home loan is usually a house or car.

Secured personal loans often use a CD or a savings account as collateral. Secured loans are typically easier to qualify for, with lower interest rates. However, if you can't make your monthly payments, you could have to give up your collateral.

Interest rates

Interest rates and fees can make a substantial difference in the amount of money you have to pay over the life of a loan. The annual percentage rate (APR) is the percentage of a loan you pay in interest every year.

For example, someone might pay 6.24% APR for a $5,000 loan with a one-year term. Every month for 12 months, they would pay around $431, which includes principal and interest. The loan would cost a total of about $170.61 in interest. Choosing a short term and having a good credit score can lower your APR.

The benefits of a personal loan

Taking out a personal loan can have many benefits. These loans often have higher limits and lower APRs than credit cards. People sometimes use them to consolidate their credit card debt and lower their interest payments. Making one payment per month is also much more convenient than sending money to several creditors. Personal loans usually have fixed rates and repayment terms, so you won't have to worry about a sudden increase in your payments because of a rising interest rate.

Payments are usually due on the same day every month, making remembering them easy. These loans are very versatile, and most banks and credit unions will let you use the money for many things, from taking a vacation to buying a new appliance to paying your taxes. Getting a personal loan and making your payments on time can also improve your credit score. It demonstrates to future lenders that you can be responsible and honor your debts. However, missing payments could lower your score. Personal loans are easy to apply for, and you can often find out whether you qualify for a loan on the day you submit your application.

How to take out a personal loan

Here are some of the steps you should consider taking to get a good deal on a personal loan.

1. Check your credit score and improve it if needed

With a high credit score, you can get a better interest rate and qualify for a larger loan. Credit scores usually fall into these categories:

  • 720 and above – excellent
  • 690 to 719 – good
  • 630 to 689 – fair or average
  • 300 to 629 – bad

Knowing your credit score can help you predict the APRs offered by different lenders. That way, you can compare companies and make sure you get a good deal. You can also estimate your total monthly payments and make sure you can afford them before you apply for a loan. It's a good idea to get more detailed information as well. That way, you can improve your score if needed. You can request copies of your credit reports from the credit bureaus, TransUnion, Experian, and Equifax.

After you look at your credit report, you can raise your credit score by disputing any inaccuracies. For example, you could see a record of a past-due medical bill in a city you never visited. Disputing that record and getting it removed from your credit report can raise your credit score.

2. Get prequalified

Prequalifying for a personal loan gives lenders more information than just your credit score. It can let you compare APRs and other loan terms more accurately. Since prequalification only requires a soft credit check, it won't impact your credit score. With many lenders, you can prequalify by filling out an online form with information like your name, social security number, and date of birth. You may need to include information about your income, employment, savings, and other financial data as well.

However, getting prequalified doesn't guarantee you a loan. After choosing a lender and completing your application, they'll perform a hard credit check to verify your information. It could lower your credit score by a few points. If the interest rate offers you get aren't affordable, you can try to increase your credit score. You can also ask someone with a higher score to cosign your loan.

3. Complete your application 

After comparing rates and choosing a lender, you can formally apply for a personal loan. Be ready to provide copies of financial documents like bank statements and tax returns. After you get approved, the lender will send you the terms of the loan. Make sure you read the fine print carefully and only agree if you can afford the monthly payments. 

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Our quick, affordable personal loans could give you the cash you need, when you need it. Apply today!

To find out more about personal loans, check out these other articles:

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