How Do Low Interest Personal Loans Compare With Other Loans?
There are four major types of commercial loans: collateral-based loans, payday loans, business loans and personal loans. Some student loans are also considered commercial loans, although government-issued student loans are not. All commercial loans share one common characteristic: borrowers are evaluated on some financial basis, either creditworthiness or ability to repay the loan.
Collateral-based loans are backed by a guarantee of collateral, like a home or vehicle the loan is being used to purchase. Jewelry, financial instruments and museum-quality art may also serve as collateral for loans.
Payday loans are high-interest loans (usually in the triple digits!) with very short lending periods, often measuring in days or weeks. Such loans are not guaranteed by collateral and are often not underwritten by conventional credit guidelines. Typically offered by free-standing lenders rather than banks, payday loans should only be used as a last resort.
Business loans may or may not be collateral based. Banks and lenders often make their decisions concerning business loans based on the ability of business plans presented by borrowers. Business loans for established enterprises are based solely on how the lender views the prospects of the business owner(s) to repay the loans, while business loans for startups or less established companies must often rely on the personal assets of borrowers in addition to business assets.
Personal loans are unsecured loans, meaning that the borrower doesn’t have to put up any proof that they can repay the loan. These loans usually have high interest rates to protect the lender in case the borrower flakes on his debt. So, where do low interest loans fit in?
Low-interest loans are also personal loans, but with the benefit of a low APR. Also known as signature loans, this kind of loan doesn’t require proof of collateral. This is due to the strict credit underwriting process lenders require before issuing the loan. In plain English, to qualify for a personal loan with favorable interest rates and related terms, you must present an excellent credit profile – or provide a co-signer with excellent credit. They are extremely difficult to get, and unless your credit history is near-spotless and your credit score is a thing of beauty, you may need to go a different route.
Good and Bad Reasons to Take a Low-Interest Personal Loan
If you are a fan of the popular Suze Orman show on cable TV, you are familiar with the “Can I Afford It?” and “Can I Afford It? Jr.” segments. Suze Orman assesses the monetary profiles of callers who seek her advice on whether they should (or should not) move ahead with a prospective financial move. Requests from adult callers range from a once in a lifetime trip for grandchildren to meet grandparents in far-flung countries, to indulgences in expensive cars. We’ve even heard of parents comparing tuition costs for preschools, which amounted to more than a 4-year college education. Yikes!
A Few Good Reasons for Taking Personal Loan
While insufficient cash enters into many of Suze’s decisions to “deny” callers, as in the case of one caller who wished to purchase an expensive car, the nature of the requests also seem to enter into her decisions. For example, the caller who wished to have her children visit their grandparent was approved although the trip would present a financial stretch. One-time expenses such as major home renovations, special occasions such as a wedding or exceptional opportunities such as specialized education represent potentially good reasons to take low interest personal loans. Consolidating high-interest credit card debt into a single payment with lower interest also qualifies as a good reason to take a low-interest personal loan.
A Few Bad Reasons for Taking Personal Loan
On the other hand, taking one loan to pay off another loan should immediately trigger red flags. Taking loans for frivolous reasons, like to buy a designer purse or timepiece, is also unwise on several levels. If you’re the parent willing to pay upwards of $30,000 to send your toddler to pre-K, you should really reevaluate your priorities. Likewise, if you lack a reliable or sufficient source of income to maintain a consistent on-time payment record, taking any type of loan is a bad decision. Never take out a loan as “insurance” to get by during tough times.
Related article: 6 Steps to Surviving on No Income
Advantages and Disadvantages of Low-Interest Personal Loans
The advantages of low-interest personal loans are obvious – they provide ready cash to cover financial emergencies as well as to financial major purchases. If you consolidate your credit card debt with a low interest personal loan, you save money in the overall amount that you’ll repay. You also enjoy lower monthly payments, so long as you do not rack up new credit card debt.
But low interest personal loans also represent potential debt traps. Even though borrowers must undergo rigorous credit underwriting to qualify, interest rates for low-interest personal loans are nearly always higher than interest rates for collateral-based loans of similar amounts. If you fall behind on the payments of a low-interest personal loan, the collection efforts taken by lenders are likely to become increasingly aggressive, including attempts to place liens on your bank accounts or other personal assets. In extreme cases, you may be faced with the prospect of declaring bankruptcy to escape your debts.
Potential Debt Traps
Even if you are borrowing for legitimate reasons, we all make mistakes. Especially if you have excellent credit and a substantial income, lenders may be a little too anxious to do business with you. Just remember that commercial lenders, unlike your family and friends, don’t have your best interests at heart. Their aim is to make money, even at the cost of detriment to you.
For instance, lenders may offer you a larger loan than you initially requested to get more money from you. Resist the temptation—loans are not gifts; they must be paid back. Be wary of unrealistically low rates. Read the fine print to determine if you are signing onto a variable rate loan. You should also determine the total amount repayable (TAR) rather than the annual percentage rate (APR) when determining how much your loan will actually cost. High origination fees may drive up the TAR of an otherwise favorable low-interest personal loan.
The terms and conditions of the loan also matter. Avoid loans with hefty prepayment penalties, even if you fully intend to draw out repayment as long as possible. You may come into a windfall and find that paying off your loan is financially advantageous.
What Are Some Alternatives to Personal Loans?
A loan should be a last resort, not a first choice. The first alternative to a loan is something you should be doing already. If you are considering a loan for a wedding a year from now, for example, it’s time to start saving money and budgeting. Planning a summer vacation? Do the same; save and budget.
Do you have a credit card with unused credit? A few rich friends? An untapped talent that can earn you some quick cash on the side? The best kind of debt is the kind that you don’t need in the first place, and only used as a tool to improve your credit score.
If you have poor credit and cannot find a trustworthy and creditworthy co-signer, you may be better off seeking a collateral-based loan. The interest rates lenders charge for personal loans to borrowers with bad credit are much higher than the interest rates available to borrowers with good credit.
If you are seeking a loan with a repayment period of 12 to 18 months, you should check out these low or zero interest credit cards before considering a low interest loan.
If You Decide to Pursue a Low-Interest Personal Loan . . .
Still want a low-interest personal loan? You better get to work. Before you begin shopping for a loan, clean up your credit profile as much as possible.
Low-Interest Loan To Do List:
Get a free copy of your credit report from each of the three bureaus. Check out our Credit Reporting Reviews page for more information.
Evaluate your current FICO score. If it isn’t excellent, fix it. CreditKarma is a great place to get your free credit score.
Pay down any credit card balances and ensure that other payments are up to date.
Assess your income for the duration of the repayment period of the loans you consider.
Secure your loan with an asset to get a better APR.
Compare banks and credit unions. Your long-time credit union may offer advantageous terms on a loan, but an outside lender may offer better incentives to get your business. You may even want to try a micro-lender, or a P2P lender, for a lower interest rate.
Compare loan terms. Low or no origination fees and no prepayment penalties trumps a lower interest rate with higher fees and stiff penalties.
Read the fine print like it’s your job. You might be signing up to allow automatic withdrawals from your checking account, or excessive fees for paying early.
We certainly haven’t shone a positive light on low-interest personal loans, or any loan for that matter. But as a last resort (or as a tool for perfecting your already-good credit), you have options. Be smart and critical, and you should get through the process unscathed.
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