The Ultimate Personal Loan Tips You Will Need Before You ApplyPersonal Loans
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Whether you’re looking to tackle an excess amount of credit card debt or need to finance a large purchase with a low-interest rate, personal loans are predictable, stable loans that can save you a lot of money when compared to other financial products. Unlike credit cards, personal loan balances, interest rates, and payment terms are all fixed, making your budget predictable and consistent.
If you’re new to personal loans or you’re not sure if a personal loan is right for your specific financial situation, we’re here to help. Money Done Right was created to help consumers make smarter financial decisions and take control of their financial health. Here’s our list of the ultimate personal loan tips you will need before you apply.
Personal Loan Basics
Personal loans are a very straightforward concept and can typically save you money when compared to high-interest purchase options, such as a credit card. To break down the basics of a personal loan, let’s take a look at how a personal loan works out mathematically before discussing the full details of a personal loan and some insightful personal loan tips.
What Does a Personal Loan Cost?
Personal loans can range from just a few hundred dollars to tens of thousands of dollars, giving consumers a wide range of loan possibilities. To help you understand the terms of personal loans and how they differ from credit cards, let’s take a look at an example loan of $10,000; you can find tons of personal loan calculators online to run through your own scenarios as well.
If you secured a personal loan for $10,000 and had a payment term of 5 years, the final component that impacts your payment is the interest rate on the loan. In this example, you secured this $10,000 loan with an interest rate of 8%. A $10,000 loan at 8% interest and a 5-year term would end up costing you $203 per month.Let’s break down each component to really discuss the pros and cons of a personal loan.
The Loan Amount
In this scenario, the loan amount is $10,000, and that principal balance isn’t going to change, which is a big advantage over credit cards.
Important note: When you keep using your credit card, that balance gets higher and higher, meaning an inconsistent monthly payment. With a personal loan, the loan amount is fixed, allowing you to plan your budget and payments accordingly. However, if you’re late on a payment or miss a payment entirely, expect some hefty fees in addition to potential catch-up payments.
The Payment Term
While this scenario had a 5-year term, personal loans typically have terms as short as one year or as long as ten years or more.
Keep this in mind: It’s common for lenders to charge lower interest rates on shorter-term loans because they recoup their money quicker. If you choose a longer term for your loan, don’t be surprised if you have to pay a higher interest rate. Even though the interest rate is higher, the longer term may give you some financial breathing room.
While it’s never ideal to pay a higher interest rate, weigh your options; are you able to pay off the loan quickly but you just don’t want a higher monthly payment?
Pro Tip: If you can afford to pay it off sooner, pay off your loan as soon as you can.
The Interest Rate
The biggest unknown variable when it comes to personal loans, the interest rate on your loan plays a major role in the overall cost and monthly payment of your loan.
- Personal loan interest rates can be as low as less than 5%, or higher than 20%, which is rivaling credit card interest rates.
- Interest rates can vary drastically, but are going to be higher than secured loans like home and auto loans.
Why? That’s because personal loans are not secured against an asset, so to protect the lender, higher interest rates are necessary.
Your credit score dictates how much you’ll end up paying in interest, so do everything you can to get your credit in shape before applying for your loan. In our scenario of $10,000 over 5 years at 8% interest, you’d end up paying over $2,100 in interest alone.
Other Fees to Consider
Some lenders may charge an origination fee, which is a one-time fee to establish the loan. While far less common than they used to be, origination fees can be as much as 10% of the loan itself. Depending on the size of your loan, that can be a significant amount of money; considering our scenario from earlier, an origination fee on a $10,000 loan can be as much as $1,000. Fortunately, there is a lot of competition in the personal loan market, and a majority of companies are doing away with origination fees.
Pro Tip: We mentioned paying off your loan as quickly as possible, but be sure to review all the terms and conditions of your personal loan before you pay it all off at once. Some lenders charge prepayment penalties, which is a fee for paying off a specific balance of your loan or the entire loan at once. These fees are typically assessed as a percentage of the principal balance of your loan, so if you did take out a large personal loan, prepayment penalties can be quite a lot.
Qualifying for a Personal Loan
Now that we’ve gone through the basic structure of a personal loan, it’s important to understand how to qualify for one by using these personal loan tips. While you may qualify for a personal loan, the interest rate might be extremely high, which could leave you in an even worse financial situation.
Here are some basics to help you secure the best possible rate.
Your Credit Score
Important to Know: Your credit score is the most important factor when determining your personal loan interest rate. Simply put, if you have a bad score, you’re going to have a high-interest rate on your loans. There are many lenders out there that approve borrowers with low credit scores, which can be helpful for those trying to build credit. However, with interest rates as high as 20% or more, it can be easy to get into financial trouble if you’re not diligent with your payments.
Pro Tip: It’s possible to qualify for a personal loan with a credit score under 600, but to get the best rates and terms, aim to have your credit score to at least 700. The higher your credit score, the better your interest rate will be, but we all know that raising your credit score is much easier said than done. The first step in improving your credit score is to review your full credit report on sites like Credit Karma and Credit Sesame.
Remember, if you’re not regularly reviewing your score and report, you may be missing errors on your report that hurt your overall score.
Check this out: Offering personalized tips and tricks, insights into your accounts and payments, and the ability to dispute errors right from the site, both Credit Karma and Credit Sesame are excellent options for monitoring your credit score.
Income and Current Debts
Aside from your credit score and payment history, lenders will also look at your current income and the current debts that you have.
Your Debt-to-Income Ratio tells a lender if you are able to handle an additional debt on top of your existing ones.
- Typically expressed as a percent, DTI is calculated by dividing your total monthly debt by your total monthly income (this can also be calculated with annual debt divided by annual income).
- Ideally, borrowers will want to have a DTI of 36% or less.
- Anything over 36% signals risk for a lender and can cause financial stress for the borrower.
- If you’re over 40%, you may have significant issues repaying your debts, and will also have a hard time getting approved for a personal loan.
Proof of Income
Even if your credit score and DTI are fair, your income could be the deciding factor when it comes to your personal loan approval. You need to be able to prove that you can afford the monthly payments for your personal loan request, and if your income is too low, you may be denied. While there isn’t a ‘magic number’ when it comes to proof of income, your DTI should give you a good indication of your approval odds.
Good to Know: If you’re between 36% and 40% and are considered ‘low-income,’ you may have a harder time getting approved for a personal loan.
Preparing for a Personal Loan
Applying for a personal loan shouldn’t be done on a whim, and with these personal loan tips, you can prepare well in advance. In fact, when you apply for a personal loan, the lender will need to do a hard credit pull, meaning your credit score will be impacted when you apply. If you’re not ready to take out the personal loan, don’t apply.
Here are some additional steps that you should take to prepare your finances for a personal loan.
Is the Loan Worth It?
When you’re shopping around for personal loans, take the time to consider if the personal loan is worth it. While the term “worth it” is certainly broad, there are a few questions to ask yourself before taking out the personal loan.
- Is the loan important? Is the loan satisfying a need, or is it satisfying a want? Distinguishing needs from wants is a helpful tactic to control your personal spending and loan habits. A loan that will help you repair your car and get to work on time is probably more important than a personal loan to upgrade your television. If you don’t immediately need to funds, chances are the loan can wait. Rather than impulse-borrowing, delaying your personal loan and saving up for your purchase may be a better option financially.
- Can your budget support the loan? Thoroughly assess your budget to see if it can even support an additional recurring payment. Personal loan payments can vary depending on the size of the loan, the interest rate, and the payment term. Again, your Debt-to-Income Ratio plays an important role in your overall financial success, and if a personal loan pushed your DTI too high, it may be time to reconsider.
- Do you understand the cost of your loan? As we’ve discussed, you need to fully understand the overall cost of your loan. There’s a lot more that goes into the overall cost of your loan than just the principal balance. Additional fees and interest can add up if you’re not careful.
How to Increase Your Credit Score
The best personal loan rates go to those with the highest credit scores. However, those with lower credit scores often need personal loans more than those with higher credit scores. Increasing your credit score may feel like a daunting task, but it doesn’t have to.
Learning how to manage your finances and keep your score consistently high takes time and practice, but there are a few personal loan tips to make an immediate impact on your overall credit score.
Even a small increase in your credit score can go a long way in terms of interest rate and total loan balance available to you. Here are some of the top ways to increase your credit score to secure the best personal loan terms possible.
Pay Down Debts
Debt plays a major role when it comes to your credit score, and if you have a large amount of debt, you may have a harder time securing a personal loan with a low interest rate.
- Credit card debt is seen as a bad debt by lenders, and a card that has a utilization of over 30% is a red flag.
- If your credit card utilization is over 30%, paying down your debt to get to 30% or below is a great way to quickly boost your credit score.
- We know, it often doesn’t make sense to pay a large amount of money simply to secure a personal loan for a similar amount of money.
- Instead of paying down debt, why not put that money toward what you were going to use the personal loan for?
Remember, personal loans often have much lower interest rates than credit cards, so if you can pay down a large portion of your credit card balance and obtain a personal loan with a better interest rate, you’re saving money in the long-run.
Consider this: you have a credit card balance of $10,000, with an interest rate of 25%.
- Your credit score isn’t the best, and you’ve been pre-approved for a $10,000 personal loan at a rate of 20%.
- Let’s say you have $5,000 to put toward either your credit card balance or your personal loan balance.
- You decide to put it toward your credit card balance and see a significant increase to your credit score.
- Instead of an interest rate of 20%, you’re preapproved at an interest rate of just 5%.
While this may seem extreme, you’d be surprised at how often this happens.
Pay On Time
Paying your bills on time is something that builds throughout the course of your payment history, but it’s important to realize the impact that just one missed payment can have on your credit score.
For example: A 30-day late payment can lower your score by 100 points or more, which can be devastating if you’re trying to secure a personal loan, auto loan, mortgage, or line of credit.
Not only does that kind of drop severely hurt your chances of being approved, but it can also take a long time to recuperate your score.
If you take away just one thing from this guide to personal loans, it’s to always pay your bills and personal loan payments on time.
Whether it’s a utility bill, credit card bill, or student loan bill, always pay your bills on time, every time. Late payments significantly impact your credit score and can stay on your report for up to seven years. While the effects of a late payment lessen as time passes, simply having a late payment remark on your credit report can make lenders wary of approving your application.
Pro Tip: Set a strict budget, map out your earning and spending, and stick to a schedule when it comes to paying. If your bills and paychecks don’t line up perfectly, consider getting ahead on your bills if possible to prevent a late payment.
Takeaway: There’s no harm in paying a bill early, but a lot of harm if you pay late.
Look for Errors on Your Credit Report
Something that many consumers may overlook is the actual credit report itself. When you look at your credit score, you also have the option to look at your full credit report at multiple credit agencies, such as Transunion and Equifax. Thoroughly review your entire report line by line to check for any errors.
Fun Fact: Some of the most common credit reporting errors include accounts that belong to someone else, account status, and account balances. If there’s an account on your credit report that doesn’t belong to you, report it right away.
The account could be impacting your reported Debt-to-Income Ratio, your payment history, and your overall debt balance. It’s also common to have accounts that don’t belong to you that are actually in collections, as they were attributed to your credit report and not the actual owner’s, meaning they may not have been advised of the past due balance.
Important! Reporting an account in collections that doesn’t belong to you can give you a significant boost to your credit score, making it much easier to secure a personal loan with competitive rates. Your account status may be incorrect as well, meaning an account that is closed may be reported as open, or an account that’s current may be listed as past due.
Remember, a past due payment history has extremely negative impacts on your credit score, and if your accounts are showing past due incorrectly, you need to report that error to the credit agency.
Pro Tip: An account balance error also impacts your DTI, and if the account balance error puts your overall credit card utilization over the recommended 30% maximum, it could have adverse effects on your credit score.
Finding a Cosigner
If your credit score isn’t where it needs to be after completing these steps, you’re not out of luck yet. Many personal loan providers allow, and often encourage, cosigners on the loan application.
What is a cosigner? A cosigner is an additional loan application that can help you secure the loan if your credit score or income don’t meet the minimum requirements.
The lender uses both your information as well as the cosigner’s information to make a determination on the loan, so try to find a cosigner that has a solid credit history to give your application a better chance.
Reality check: Don’t be surprised if your friends and family are hesitant to cosign on a personal loan application with you. If you aren’t able to pay the loan, your cosigner becomes responsible for the balance, and a late payment on your end will actually impact their credit score as well. While a cosigner may be able to give your application the help it needs to get approved, only ask someone to cosign on a loan if you’re confident you’ll be able to pay it back.
Shop Around for Rates
It’s never been easier to shop around with multiple lenders to find the best possible rate for your personal loan. There are plenty of personal loan comparison networks online that can connect you with multiple lenders in just minutes.
Looking for a personal loan comparison? Upgrade is a site that connects you with multiple lenders that provide personalized rates, all without impacting your credit score.
Important! Considering a hard credit pull will lower your credit score, checking your rate offers without impacting your credit score lets you shop for the best rates without worrying about your credit score decreasing with each inquiry.
- Simply enter your information, such as your requested loan amount, reason for the loan, and your financial information, then review your personalized loan matches.
- Apply right from the site and get your funds deposited in as little as 24-hours.
- Before you sign the dotted line, always review the terms and conditions of your loan.
- We all hate reading the fine print, but there’s important loan information in there that you need to know before you sign.
- In addition to understanding your interest rate and payment terms, review information about any prepayment penalties, late fees, and payment methods available to you.
- Finally, do some additional research into various lending companies by reading real customer reviews.
Ways to Use Personal Loans
Personal loans are becoming increasingly popular for a wide range of financial needs. Purchases that were once primarily made on credit cards are now being financed through personal loans, and for good reason.
Good to Know: Consistent monthly payments, low interest rates, and the ability to choose your payment terms are just a few of the many reasons that personal loans are on the rise.
While personal loans aren’t designed for all purchases, here are some of the top ways that personal loans are used today.
One of the most common reasons that personal loans are used is to finance a large purchase. Rather than putting a large purchase on a credit card with interest rates at 20% or more, a personal loan allows you to finance a major purchase with a much lower interest rate.
Fun Fact: Two common major purchases that are often financed with a personal loan are cars and home improvement projects.
- You shouldn’t use a personal loan to finance a car purchase if you’re purchasing through a dealership, as you’ll often get a better interest rate with a dedicated auto loan through a lender.
- However, if you’re purchasing from a private party, a personal loan is a very practical way to quickly get the funds you need to make the purchase.
Personal loans are even more common for home improvement projects. In fact, many personal lenders now offer home improvement-specific loans, making it even easier to upgrade your home. Since homes appreciate over time and gain value as you make upgrades, it does make financial sense to finance a home improvement project with a low-interest personal loan. Depending on your financial situation, you may consider a personal loan for other large purchases, such as appliances, equipment, or expensive electronics.
If you’re able to wait to make one of these purchases and save up your money to avoid taking out a personal loan, this is always the best option.
Another very popular reason that consumers take out personal loans is to consolidate debt.
Fun Fact: The average APR on credit cards is just under 16%.
- Personal loan rates can range from as low as under 5% to as much as 30% or more, depending on your credit score and the lender you choose.
- If you opened a credit card when you had bad credit, you more than likely have a higher interest rate than 16%.
While you may be able to negotiate a lower interest rate as your credit score improves, that’s not always possible.
Now that your credit score has improved, you shouldn’t be forced to pay that same rate on your outstanding balance. With a personal loan, you don’t have to.
Good to Know: Personal loans are ideal for debt consolidation because they typically lower your interest rate and they create set, consistent payments month over month. Rather than waiting for your credit card company to tell you the minimum payment due every month, you’ll know exactly what you need to pay when you take out a personal loan to consolidate your existing debt. You may want to consider a balance transfer credit card offer as well.
- These offers can range from six months to 21 months, allowing you to pay 0% interest on the transferred balance throughout the promotional period.
There is typically a small fee involved with transferring a balance, but if you’re able to pay off your balance before the promotional period ends it’s a great way to save on interest costs.
Financing a Business
Over 500,000 businesses are started every month, and financing a new business has to come from somewhere. While there are dedicated small business loans designed to help small businesses grow, your business may not necessarily qualify for one of these loans. If your business is not yet established and producing stable cash flow, you may need to tap into your personal credit history to secure funding. A personal loan can be used to finance a new business and is often a much better choice than a credit card, even if it is a dedicated business credit card.
If you’re established as an LLC, your personal loan wouldn’t be offered the same protections as your business loans or business lines of credit, but a personal loan is still a good option if you can’t secure a business loan.
Finally, you can use a personal loan to help build your credit history. It’s common for consumers to turn to a credit card to start building their credit. While it’s easy to use a credit card to build your credit history, it’s even easier to establish bad spending habits with a credit card.
Bad spending habits: Too often we see young borrowers open a credit card account with the intention of using it to boost their credit, only to have it do much more harm than good. Falling behind on payments, overspending, and lacking discipline when it comes to paying off the entire balance each month are just a few ways that so many of us get into financial trouble with our credit cards.
Goo to Know: Rather than having a revolving credit account that you can use over and over again, a personal loan is a smart, safe way to help build your credit history and score. With set rates, simple loan terms, and a consistent, predictable monthly payment, it’s often much easier to pay a personal loan on time. Start out with a small personal loan balance and always pay on time or ahead of schedule.
Pro Tip: Since your payment history plays such an important role in your overall credit score, establishing good payment history early is vital for building your credit score in time for larger purchases down the road.
Common Personal Loan Scams
With so many personal loan options available today, there are also plenty of scam artists out there that prey on consumers looking for personal loans. These scams can end up costing you thousands of dollars if you’re not careful, and they’re becoming much more sophisticated, meaning it’s increasingly difficult to identify personal loan scams.
To help out, here are four of the most common personal loan scams we see today.
No Credit Checks
If you come across a personal loan company stating that they don’t need to pull your credit to issue you a loan, turn the other way.
- There is no method that lenders can use to determine a loan’s interest rate other than pulling your credit report.
- Your credit report shows your overall debt balance, payment history, and important financial information that allows lenders to determine your rate.
- Before a personal loan is closed and finalized, the lender will need to do a hard credit pull, which is different from the soft credit pull that doesn’t impact your credit when you’re shopping around for rates.
Don’t believe a lender when they say they can offer you an interest rate based on anything other than your credit report.
Unsolicited Email Offers
If you receive unsolicited email contact from a lender offering a personal loan, chances are it’s a scam. However, if you’ve been shopping around for rates on multiple lending sites and check your rate with a soft credit pull, you more than likely opted in to additional email communications from the lender and its partners.
Good to Know: Never click on suspicious emails or suspicious links in your email. All it takes is one click for your sensitive personal information to be compromised.
A legitimate lender will never require you to pay an upfront fee for your loan. Why should you have to pay out of pocket to secure a personal loan?
Upfront fee scams have evolved over time, and the most common upfront fee scam involves asking for your bank account information to verify you have funds to cover the loan. When you provide your bank account information, your bank account becomes compromised, meaning your money is at risk. Personal loans are unsecured loans, so there is never a need to pay an upfront fee. If there are origination fees involved, which are also unnecessary, they are rolled up into the loan itself rather than an upfront fee. With so many lenders out there offering fee-free loans, you shouldn’t have any problem with upfront or origination fees.
While not necessarily a scam, prepayment penalties have been called into question in recent years. There are personal lenders that do have prepayment penalties, but they’re quickly disappearing from the industry.
There are tons of personal lenders that do not have prepayment penalties, and those that do have prepayment penalties are beginning to follow industry trends. If you come across a lender with prepayment fee, keep shopping around.
Alternatives to Personal Loans
Personal loans are a great option for many financial situations, but there are some drawbacks that you need to consider before taking out a personal loan. First and foremost, if you aren’t diligent about making your personal loan payments on time, expect a serious hit to your credit score.
With so many lenders available at the click of a mouse, borrowing money through a personal loan is easier than ever. The easier it becomes to secure a personal loan, the easier it becomes to create bad financial habits, such as overspending.
Good to Know: A personal loan may not be the best option for loans that already have existing, specific loan products available. For example, you wouldn’t necessarily take out a personal loan to purchase a car or buy a home, but there may be instances where a personal loan may be appropriate.
Additional info: If you purchase a car from a private seller, or need some additional funds to upgrade your home, a personal loan is a great solution. Oftentimes a combination of a personal loan and another loan product may be the best call for your purchase.
Should I Use a Credit Card Over a Personal Loan?
If you need consistent access to funds, a credit card may be a better option than a personal loan. Establishing good spending habits with your credit card is vital for your financial success. Pay off your credit card balance and take advantage of various credit card reward programs to maximize your credit card benefits.
As you can see, there’s a lot that goes into understanding and successfully managing personal loans. A personal loan is a fantastic option for debt consolidation, large purchases, and simply boosting your credit, but can become a problem if you’re not careful with your budget and financial planning. Before diving into a personal loan, consider if the loan is worth it and if you can support the additional payment in your monthly budget. Get a good understanding of your interest rate and payment terms, and don’t be afraid to shop around with various lenders. Consider your options and potential personal loan alternatives.
- It wouldn’t make sense to finance your college education with a personal loan when so many student loans offer even lower interest rates. However, there may be times when a personal loan is ideal, such as using a personal loan to finance an expensive laptop that you need in college.
Whatever you use a personal loan for, we hope our guide to personal loan tips has helped you navigate your personal finances.
Have your own personal loan experience? Tell us about it in the comments below!
Logan is a practicing CPA, Certified Student Loan Professional, and founder of Money Done Right, which he launched in July 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.