Personal Loan Options

What Are Personal Loans?

Personal loans used to be a simple part of the American economy. Homegrown savings and loans lent money to buy boats and barbeque pits based on the reputation of their customers. If you had a job, paid your bills on time and were known to be honest, there was loan money available.

Personal lending has changed — a lot. In today’s mass society, giant national and regional banks dominate, and loan underwriting is anything but personal.

Though banks still make open-ended loans to their best customers, the review process can be difficult, and the terms might discourage all but the most determined customers. Today’s borrowers often turn to family members, friends and peer-to-peer lenders for personal borrowing.

Personal loans can be used for everything from funding an education or financing a new business venture to paying bills or taking a lavish vacation. Unsecured loans are made without collateral, so lenders consider them risky.

Credit card debt is unsecured, since the lender has nothing to seize if the borrower defaults. In many cases, lenders do background and credit checks on potential borrowers to assess their risk.

Personal loans have evolved over the years to meet the changing needs of the consumer. It used to be nearly impossible to get a personal loan with a limited or poor credit history, but today there are loan options for people with bad credit and those without a detailed financial track record.

Benefits of Choosing a Personal Loan

One benefit of a personal loan is in the name: It’s personal. You can use it for any reason you like. You can cover practical expenses like credit card consolidation or remodeling a bathroom to something whimsical like buying a boat or taking a European vacation.

Personal loans, especially unsecured ones, usually require an application and verification of your financial standing. Though banks or credit unions make personal loans, the new trend is toward less conventional lenders.

Family and friends can be the source of money, though it is advisable to have a formal loan agreement with them to make sure the relationship doesn’t go sour.

There also are many peer-to-peer online lending sources like Prosper and Lending Club, as well as sites like Kickstarter.com and IndieGoGo.com that cater to entrepreneurs. The online sites normally charge a fee, but if you need money quickly, they represent an option.

Other benefits of personal loans:

• You get the money faster. In most cases, approval is much quicker than with conventional loans.
• Don’t need a bank. The money could come from a credit union, an online lender, a family member, or friend.
• Fixed-rate interest, fixed length of repayment, and fixed monthly payments.
• Loan amounts available from $1,000 to $100,0000.
• Lower interest rates than credit cards.
• If a loan comes from a bank, possible discounts on interest rates.

Secured vs Unsecured Personal Loans

The differences between a secured loan and an unsecured loan are important. Deciding which loan is best depends on a variety of factors, such as whether you want to risk losing your house if you fail to pay back the loan.

One thing to keep in mind is it’s typically easier to get a secured loan because you’re backing it with collateral. You’ll also likely get a lower interest rate, because secured loans aren’t as risky to lenders.

Secured Personal Loans

A secured loan means you’ve put up something you own – an asset – as collateral. If you don’t pay the loan on time, the lender can seize what you own. Among the assets borrowers use are their houses for mortgages, and their automobiles for car loans.

Unsecured Personal Loans

Unsecured personal loans do not require collateral. If you don’t pay it back on time, the lender cannot seize any of your property. Credit cards, for instance, are essentially unsecured loans.

That doesn’t mean there are no consequences if you fail to repay such loans. The default will be reported to credit bureaus, and your credit score will drop. You’ll likely have to pay higher interest rates on future loans.

Types of Personal Loans

Lenders offer a wide array of personal loans to satisfy various needs. Your financial condition, whether you own a home and your military status, can influence the type of loan you receive.

The eight most common types of personal loans are:

1. Home Equity Personal Loan: Lump-sum loan secured by your equity in your home.
2. Home Equity Line of Credit (HELOC): The revolving amount is taken as needed and secured by the equity in your home.
3. Short-Term Personal Loan: Taken when funds are needed urgently.
4. Fast Cash-Advance (or Payday) Loan: Taken when funds are needed immediately. Such loans often come with very high interest rates and difficult repayment terms.
5. Military Payday Loan: Specific to men and women in the military.
6. No Credit/Bad Credit Personal Loan: For consumers with a bad or limited credit history.
7. Second-Chance Personal Loan: For a financial crisis or personal tragedy
8. Private Education Loan: A personal loan for college students.

Fixed-rate Loans

A fixed-rate loan has an interest rate that does not change. Most personal loans have fixed rates.

Variable-rate Loans

Variable-rate loans are the opposite of fixed. They fluctuate based on market conditions.

Debt Consolidation Loans

If you have a lot of unsecured debt, like medical bills and credit cards, you can combine them and pay them off with a debt consolidation loan. The advantage is that a single loan typically has a lower interest rate than what you were paying on all those separate debts. That lets you pay it off faster, and it’s more convenient to have just one monthly payment.

Joint and Co-signed Loans

If you don’t qualify for a personal loan on your own, lenders might approve one if somebody cosigns for you. That means they are promising to pay the loan if you fail to keep up payments. That person must prove they are credit-worthy, and they would not have direct access to the loan.

A joint loan has the same requirements. The difference is the co-signer has access to the funds. If a payment is missed or there’s a default, it will damage the credit score of both people.

Personal Line of Credit

A personal line of credit is like having a credit card. Like your credit limit, there’s a maximum amount of money you can borrow.

You don’t have to spend the entire amount. You withdraw money as needed and pay interest only on what you borrow. As with credit cards, the interest rate is variable. The advantage is that the rate is typically lower with a personal life of credit.

Installment Loans

These are commonly referred to as “Buy now, pay later” (BNPL) loans. You buy an item like a refrigerator or riding lawn mower, but don’t have to pay the purchase price up front.

The balance of the purchase is broken into smaller installments. These loans are usually offered by large stores and BNPL companies. You authorize them to charge you the balance of your purchase, usually in bi-weekly installments.

BNPLs are tempting if you can’t pay the full price for something. Just be sure you can cover the installments because late payments will be reported to the three credit bureaus.

Peer-to-Peer Lending

Peer-to-peer loans, also known as P2P, person-to-person, or social loans – have become an important source of borrowed money in the Internet age. Many websites specialize in connecting those needing loans with investors willing to lend money.

Several companies, including Lending Club. Lending Tree and SoFi, are major peer-to-peer lenders and have worked to standardize lending practices. The company lures investors with favorable rates of return and then loans the invested money to borrowers. Lending Club only deals with borrowers with good and above-average credit scores and charges an origination fee of 1% to 6% of the loan’s value.

Some borrowers use peer-to-peer loans to pay off higher interest debts like credit cards or possibly Buy Here Pay Here auto loans. Lending Club, for instance, charges rates from 5.99% to 35.89%. The loans allow early repayment without penalty.

Peer-to-peer lenders typically use borrowers’ debt-to-income ratios, income, financial history and career experience to decide to whom they’ll lend. Some lenders will advance as much as $100,000, though typically loans are for $35,000 or less.

Pros and cons of peer-to-peer lending

• Loans can be used in place of second mortgages or home equity lines of credit (HELOCs) for needed cash. Unlike bank real estate loans, they don’t require collateral nor is the application cumbersome.
• Interest rates can be lower than other forms of financing, especially debt accrued on credit cards.
• Investors who fund peer-to-peer loans find them attractive because the rate of return can be substantially higher than on conventional investments.
• Loans can be risky. Though loan facilitators do extensive background checks on borrowers, collection can be difficult. Since the loans aren’t insured, the lender bears all the risk. Generally, lenders protect themselves by restricting the amount they’ll loan to any one borrower.

Borrowing from Family and Friends

Family members can be a valuable source for borrowing money. Whether the loan is used to make it through a rough patch, make a down payment on a house or start a new business, family and friends can offer invaluable help for reaching your financial goals.

Family lending is huge in the United States. The Federal Reserve Board reports loans from family and friends total about $89 billion a year. Though family members can be a huge help, borrowers often don’t repay their generosity. CNN Money says that about 70% of loans made by family and friends are either partially repaid or not repaid at all.

This most personal form of borrowing should be carefully thought out and terms should be set – in writing. A loan contract should include the amount borrowed, the interest rate if one is charged, and the repayment terms. The agreement should also spell out the lender’s recourse if the borrower defaults. That includes restructuring the loan or taking legal action.

Understanding the transaction is key to both the lender and the borrower. Remember the difference between a loan and a gift. Loans come with promissory notes, and they must be reported on tax returns.

The Internal Revenue Service requires that interest be paid on lent money. When you devise a loan agreement, make sure it includes an amortization table that spells out how much interest must be paid and sets out a schedule for payments.

How to Apply for a Personal Loan

Applying for a personal loan is like going shopping. You’re looking for the best deal, but you need to be fully informed before you hit the stores. Here are the basic steps to get there.

• Check your credit score. The higher it is, the better deal you will get on a loan.
• Calculate your loan payments to make sure you can afford the monthly hit to your bank account.
• Research and compare lenders to find out their interest rates, fees and loan availability.
• Get prequalified. Lenders will perform a soft credit check to assess your finances. That allows them to preview loan offers for your consideration.

Considerations for Applying for a Personal Loan

You should ponder these questions before applying for a personal loan:

• What is the purpose of the loan?
• What is your credit score and what type of interest rate do you expect to receive based on that score?
• How much are you going to borrow, and can you comfortably afford the payments on that amount?
• How long a repayment schedule can you handle, and do you want a secured or unsecured loan?

Once you have the answers, gather the documents required to verify financial information. You may need tax returns, checking and savings account information, deeds for property, and titles for cars. You may need all or parts of that list, depending on the size of the loan you’re seeking.

Finally, you will need the usual personal information – name, age, address, social security number, and contact numbers – and something to verify each one.

Many loan applications are rejected because the borrower couldn’t provide the documentation needed for approval. It’s important to assemble all necessary paperwork together before you start filling out the application.

One more bit of advice: Shop around. It may feel like you’re begging for help when you start the process, but the truth is, you’re the customer. If the lender wants your business, they will work with you to get a deal done. If not, keep shopping.

Qualifying for a Loan

Since most personal loans lack collateral, lenders will scrutinize your credit history, your income, and your debt level before approving financing. Your credit history, and your credit rating, will help determine how much interest you’ll pay. The lower your credit score, the higher the interest rate and the less you’ll be able to borrow.

Since there are many varieties of personal loans, there’s no single formula for qualifying to borrow. Payday lenders, for instance, will often loan money in anticipation of a paycheck or a tax refund.

Payday lenders often require a credit check but might charge interest rates of 400% or more. The high interest can prove disastrous for borrowers, so be wary of such lenders and always consider the terms of the loan. Too many borrowers fail to understand how interest accrues and come to regret their decision.

Some lenders will transact with people with low credit scores but will charge relatively high interest rates – often as much as 36%.

As a rule, avoid payday lenders and carefully evaluate repayment terms and interest rates before borrowing. Personal loans can be cheaper than credit card balances and offer a way to consolidate several debts into one.

Credit card debt is revolving debt while personal loans are installment debt. Credit rating agencies treat revolving and installment debt differently and transferring debt from revolving to installment can improve your credit score.

How is My Credit Affected by a Personal Loan?

Getting a personal loan and making on-time payments will help your credit score, but not right away. The process is like taking one step back to take two forwards.

The step back is that the lender you choose will make a hard credit inquiry. That’s a detailed review of your credit history to judge your ability to repay the loan. It can lower your credit score by five to 10 points.

The good news is you can quickly regain those points and start adding more. If you are using a personal loan to consolidate and pay down credit card debt, you might discover that your credit score improves rapidly.

A significant part of a credit score is based on credit utilization, which is the percentage of your credit in use. Since personal loans generally don’t involve a credit line, transferring debt from revolving credit card debt to the installment debt of a personal loan will lower your credit utilization amount, and that will have a favorable impact on your credit score.

Personal loans can help you rebuild credit and pay off debt without the help of a debt consolidation company. This can save you money, but it isn’t an option for everyone. If your credit score has dropped below 580 as a result of high amounts of revolving debt, it is unlikely you will be able to find a personal loan that makes financial sense.

Before seeking a personal loan, it pays to know your credit score and find out what interest rates lenders charge. The lower your score, the higher your interest rate will be.

If you think you’ll have a hard time making on-time payments on your loan, think twice about borrowing the money. Defaulting on a personal loan can severely damage your credit score if the default is reported to one of the rating agencies.

If you borrow money from a family member and fail to repay, you might lose an important relationship and if you signed a contract, you could be sued. So always think ahead.

Taking Out a Personal Loan: Banks vs. Credit Unions

Banks and credit unions are the most common sources of personal loans. Both have positives and negatives, and it’s up to the borrower to decide which option is best.

It’s important to know the difference between a bank and a credit union. Both banks and credit unions are publicly chartered, regulated institutions. Banks are for-profit businesses and credit unions aren’t. Shareholders own banks, but credit unions are owned by members, which credit unions call their account holders.

Although banks have been a more accessible borrowing option in the past because of the large pools of capital they manage, credit unions are growing in popularity. Recently credit unions have become competitive with banks, offering lower fees and higher levels of service. In addition, membership in credit unions has become much less restrictive, making them available to a larger and more diverse population.

Personal loans can be useful, but only if borrowers understand how they work and follow the rules for paying them back. When considering a personal loan, borrowers should consider the amount of interest they’ll pay and any difficulties they anticipate making payments. If your job is in jeopardy, it might not be a good time to take out a loan that requires uninterrupted payments.

Types of Personal Loans to Avoid

One of the first things to do when shopping for a personal loan is to check the interest rate. If it’s above 25%, be wary. Somebody might be out to take advantage of you. Here are some loans to think twice about:

• Payday Loans: You get the money but must repay it on your next payday rather than in installments. These loans are usually for a few hundred dollars and are geared toward people with poor credit scores who don’t qualify for more reasonable interest rates. They have steep fees and interest rates can be 300% or higher.
• Cash advance apps: The apps let you get fast cash, typically between $200 and $500, and pay it back on your next payday or within two weeks of getting the loan. Interest rates are high, and some charge monthly subscription fees.
• Credit card advances: Some credit cards can be used to get cash advances from a bank or ATM. You’ll be whacked with a fee that can be as much as 5% of the amount borrowed, as well as higher interest rates on the new cash.
• Pawn shop loans: The pawnbroker will offer you a loan in exchange for collateral, which could be anything of value that you own. The interest rate is usually well over 100%, and the pawn shop will sell your collateral if you fail to repay the loan.
• Title loans: Borrowers are required to put up their automobile as collateral. They’ll get a lower interest rate than payday loans because the loan is secured, but the lender will have the auto’s title and will sell the car if the borrower defaults.

Personal Loan Scams

If you have limited financial experience or are a trusting soul, you could be a target for scam artists.

Scam artists take advantage of the most vulnerable members of society, stealing millions of dollars every year from unsuspecting people who thought they were getting a good deal on a personal loan.

If you aren’t experienced at borrowing money, be cautious at all times, whether you’re talking to a lending institution down the street or an online lender offering you a deal that seems too good to be true. It probably is.

Things to look out for when looking for a personal loan

• Advance payment fees: The lender will ask for a fee to review or process your loan. They may refer to it as an application fee, document fee or even an insurance fee, but legitimate lenders don’t ask for money in advance of giving you a loan. They disclose all fees and usually roll them into the cost of the loan.
• Wire transfers: If the lender tells you to wire money for the fees he proposes, that is a problem. Verify the business name and a physical address for the lender to be sure it’s a legitimate business. Never wire money to an individual.
• Guaranteed loan: There are some lenders who will call or send invitations to apply for a personal loan with a “guarantee” that you will be approved. Ignore them. The guarantees can’t happen until your credit score and financial situation have been evaluated.
• Interest rate inflation: The interest rate for nearly every loan is determined by some combination of credit score, amount borrowed and repayment schedule. Inflating the interest rate by just a point and stretching the repayment schedule a few years can be very costly to borrowers.
• Companies with copycat names: It is common, especially online, for scam artists to create a company name that sounds and looks familiar, but it is a fraud. It is crucial to verify the business name and address before signing on with a company.
• Personal information requests: Be careful not to give your date of birth, social security number, checking account number or any other important personal information unless you’re positive you’re dealing with a legitimate lender. Otherwise, you open yourself up to things like identity theft or having money stolen from your bank account.

Speak to a Credit Counselor Before Applying for a Personal Loan

If you need a personal loan to pay bills, chances are your financial situation isn’t ideal. To improve that, you should consider getting advice from someone who is trained to help people manage money.

A good place to start is a nonprofit credit counseling agency. They have certified counselors who might suggest strategies like a debt management program to help you get out of debt and onto a firm financial footing. Each consumer is different, so counselors can determine whether getting a personal loan is a good idea for you.

If it isn’t, they’ll suggest alternatives. If it is, they can guide you through the process and help make sure your personal loan will truly pay off in the end.