Personal loans have been around for a while, but online fintech lenders have reinvigorated this form of financing. As banks and credit unions scramble to offer more loan products and match the convenience of the fintechs, terms and interest rates get more competitive.
Whether you need funds for a car, dental work or an emergency, a personal loan can be a financesaver.
What is a personal loan?
A personal loan is money borrowed from financial institutions or online lenders, and paid back in fixed installments. With interest on top.
Most personal loans are “unsecured loans,” meaning you don't need to put any money down — or offer up collateral like your car or your house.
Personal loans are increasingly popular, because they can be used for practically anything. While the number of mortgages dropped considerably over the last decade, unsecured loans rose dramatically.
Credit reporting giant TransUnion predicts personal loan balances will total a record $156.3 billion by the end of 2019.
How do personal loans work?
A personal loan is clear-cut. There’s a beginning and an end.
Let’s say you want to consolidate your debts or update your kitchen appliances. You get a personal loan for $8,000.
In most cases, you’ll have two to five years to pay it back in monthly installments at a fixed, simple interest rate. Payments will be the same every month for the life of the loan. You’ll always know exactly what you owe and how long you have to pay it back.
Because person loans are commonly unsecured, interest rates may be higher than for mortgages or car loans. If you default on one of those, the lender can always repo your ride or foreclose on your home.
Still, interest rates on most personal loans are significantly lower than the rates on credit cards. Personal loan rates typically range between 6% and 36% APR.
Limits on how much you can borrow are typically higher, compared to credit cards. According to TransUnion, banks and fintech lenders typically issue loans in the $10,000 range. Credit unions, extending around $5,300, aren’t quite as generous.
The average personal loan is for around $8,400. That’s not too shabby if your transmission goes out or your daughter gets engaged.
Types of personal loans
The types of personal loans consumers might consider include:
- Unsecured personal loans
- Secured personal loans
- Fixed-rate loans
- Variable-rate loans
- Debt consolidation loans
- Co-sign loans
The most common are unsecured loans. Since they’re not backed by assets, they’re riskier for lenders. That’s why they typically have higher interest rates.
A few lenders offer secured personal loans. You can borrow against an asset, such as a car title or savings account, to get a better rate.
The loans are available at fixed or variable rates. Fixed rates are most common, especially for long-term loans. Borrowers like them because they needn’t worry about their payments increasing, which makes budgeting easier.
Other borrowers prefer a variable rate for short-term financing. Monthly payments may rise or fall slightly, but the difference on short loans is negligible. The advantage to a variable-rate loan is a lower annual percentage rate.
A debt consolidation personal loan is ideal for anyone whose debt is all over the place. One loan pays off all the balances. It is repaid, usually at a lower interest rate, in convenient installments to one creditor rather than several.
If you have a patchy or nonexistent credit history and don’t qualify for a loan on your own, you might consider enlisting a co-signer. In that arrangement, someone with a better financial record agrees to repay your debt if you default.
A co-signed loan can be a blessing or a curse. Carefully assess your ability to repay before you ask a friend or relative to cosign.
How to get a personal loan
Here are the steps for obtaining a personal loan:
1. Check your credit score before you apply. Your credit history has significant bearing on approval and your interest rate.
2. Do the math. The last thing you want to do is borrow more than you can handle. Determine how much cash you need. Use an online loan calculator to get a rough idea of what your monthly payments will be. You can play around with various interest rates until you have hard numbers.
3. Shop around for the best personal loan rates. Choosing the right lender could save you thousands of dollars. Most lenders post their borrowing limits and required credit scores on their websites.
Origination fees for processing the application are common, but watch out for prepayment penalties. You shouldn’t be punished for getting out of debt as quickly as possible.
4. Apply online or in person. You’ll be asked to provide financial information such as income, the amount of your house payments and your debt-to-income ratio.
The lender will do a credit check based on your information. Approval and funding could take anywhere from one business day to a week or so depending on how you applied.
When to get a personal loan
Now you know how to get a personal loan, but under what circumstances should you get one?
1. You're short on cash. If you’re hard-pressed and find yourself taking cash advances on a credit card, you’re probably paying sky-high interest rates. You’d be better off getting a loan.
2. You're buying a car. Traditionally, car loans have lower interest rates. Would it ever make sense to finance new wheels with a personal loan? It would if you don’t have a great trade-in or sizable down payment.
3. You have a personal emergency. It goes without saying that you shouldn’t hesitate to use a personal loan for emergencies, like an urgent medical procedure. But remember, it's best to have anemergency fund for those situations.
4. You're consolidating credit debt. If you have a couple different cards maxed out, you can clear them with a personal loan and pay the balance on your loan in monthly installments instead. This makes the most sense if you're able to get an interest rate lower than what you would pay in credit card interest.
Personal loans aren’t always the best way to go. The biggest drawback comes down to interest rates. If you’re willing to stake your assets, secured loans are usually more affordable than unsecured loans.
How will personal loans impact credit score?
Each time a lender pulls up your credit history, your score takes a slight hit. This is known as a hard inquiry, and it typically stays on your credit report for two years.
Avoid repeated dings to your score by rate-shopping within a 45-day period. All inquiries during that time will be treated as a single inquiry.
Obtaining a loan from a longtime banker who is familiar with your history might not affect your score at all.
Repaying a personal loan in full and on time will put you in a good financial light for years to come.
What’s a good interest rate these days?
As you comparison-shop, you’ll find that rates vary widely from lender to lender.
As we said, rates on personal loans typically range from 6% to 36%, and the average is 17.31%, according to Experian.
The best personal loan rates are awarded to the borrowers with the best credit scores. If you have poor credit and can put off your loan for a few months or a year, use the time to clean up past mistakes and boost your score.
What is a personal loan? If you handle it responsibly, it’s a great tool for increasing your borrowing power. Then, you can seize opportunities as they arise.