Complete Guide to Personal Loans

Everything you need to know about finding the right personal loan

Personal loans can help borrowers do anything from debt consolidation to financing a vacation or wedding ring. But if you’re not careful, a personal loan can become a drain on your finances.

What’s more, personal loans are a dime a dozen, making it difficult for borrowers to find the right one.

If you’re considering a personal loan, the more you know about them, the better. Read on to learn everything you need to know.

What is a personal loan?

A personal loan is a type of debt that has a set repayment term and monthly payment. Depending on the lender, you can borrow anywhere between a couple hundred to tens of thousands of dollars.

Personal loans are issued by banks, credit unions, and various other financial institutions. There are personal loan options for people with all types of credit, including bad credit.

Types of personal loans

There are two types of personal loans: unsecured and secured. Unsecured personal loans are more common and don’t have any collateral backing them. This means that, if you default on your loan, it could hurt your credit, but the lender won’t repossess any of your possessions or savings.

Most personal loans are unsecured. This means two things. The borrower doesn’t have to put up any collateral for the loan, and the borrower will pay a higher rate than with a secured loan.

Secured personal loans, however, require collateral. The lender can take the collateral funds to pay off the loan if you stop making payments.

A secured personal loan is generally only a function of credit building activities. Many credit unions will offer personal loans that are secured by the money in a savings account.

Rates and fees

Every personal loan is different, so it’s important to compare the terms of several personal loans before you apply for one.

Here’s a quick breakdown of some major terms to note:

Interest rates

The average interest rate on a personal loan with a 24-month repayment period is 10.31%, according to May 2018 data from the Federal Reserve. But depending on the lender and your credit and income situation, the rates can vary wildly.

Personal loan companies typically offer fixed interest rates or a mix of fixed and variable interest rates. While fixed rates stay the same throughout the life of your loan, variable rates can change over time as market rates fluctuate. As a result, variable interest rates are typically lower at the start than fixed rates.

But because variable rates come with less certainty, fixed rates are usually better for longer repayment periods. These periods can typically range from one to seven years.

Fees

Fees can vary depending on the lender, but here are some common ones to know about:

  • Origination fee: The lender takes this fee out of your loan disbursement to cover the cost of originating the loan. It’s more common with lenders that sell loans to other lenders, but that’s not always the case. If a lender charges an origination fee, it can be anywhere between 1% and 8%.
  • Late fee: If you miss a payment, a lender may charge a flat fee or a percentage of your missed payment.
  • Returned payment fee: If your checking account doesn’t have enough to cover your monthly payment, it could fail, and you may be charged a returned payment fee.
  • Prepayment penalty: If you pay off your personal loan early, you could be charged a fee to make up for the lender’s lost profits. This fee is uncommon, especially among top personal lenders.

As you shop around, carefully consider the fees each lender charges. Also, note that some personal lenders don’t charge any of these fees.

What to use a personal loan for

You can use a personal loan for just about anything. But some lenders may have some restrictions.

For example, you can’t use your loan funds for anything illegal, and you may not be able to use a personal loan to refinance student loan debt or pay for college costs.

Also, some personal lenders have loans designed specifically for one purpose. Payoff, for instance, only offers loans to help you consolidate credit card debt.

Here are some general ideas for how to use your personal loan funds:

  • Consolidate high-interest credit cards or other debt.
  • Cover medical expenses.
  • Take a vacation.
  • Renovate your home.
  • Purchase a car.
  • Pay for moving expenses.
  • Start a business.
  • Boost your credit.
  • Cover emergency expenses.

When not to use a personal loan

While it’s possible to use a personal loan for just about anything, that doesn’t mean you should. In general, you should avoid borrowing with a personal loan in cases where you can get better terms with a different loan type, or it’s better not to borrow at all.

Using a personal loan for an unnecessary purchase will only increase the cost of the item and limit your monthly budget for the term of the loan.

For example, you can use a personal loan to finance a dream vacation, but it might be a good idea to save up for it instead. And if you’re buying a car, you might get a lower interest rate through an auto loan that’s secured by the vehicle as collateral. Different personal loans come with different rates, fees, and requirements, but you can check out the pros and cons of each to ensure that you choose the best personal loan for you.

Personal loans vs. alternative financing options

Depending on the situation, one loan type may be better than the other. To help you decide, here are some comparisons between personal loans and other top loans that are also worth considering:

Personal loans vs. credit cards

Personal loans are best if you want to consolidate high-interest debt or if you want to finance a large expense over time and can get a lower interest rate.

On the other hand, credit cards are generally better for everyday expenses that you can pay off each month. Also, some credit cards offer 0% APR promotions that can help you save on interest.

WEIGH THE RISKS & BENEFITS

Compare the features of personal loans and credit cards before you make a decision.

Personal Loans

  • Installment loan.
  • Have a set repayment term.
  • It can be secured or unsecured.
  • Charge interest each month.
  • The account closes when you pay off the loan.

Credit Cards

  • Revolving line of credit.
  • No set repayment period.
  • Can be secured or unsecured.
  • Charge interest only if you carry a balance.
  • The account stays open as you use and pay off your credit line.

Personal loans vs. home equity loan or line of credit

If you’re looking to consolidate debt or make some home improvements, you may consider a personal loan or a home equity loan or line of credit.

While a personal loan won’t put your house at risk, you may be able to deduct interest from your taxable income if you use a home equity loan or line of credit to buy, build, or improve your home.

WEIGH THE RISKS & BENEFITS

Compare the features of personal loans and home equity loans before you make a decision.

Personal Loans

  • Installment loan.
  • Can be secured or unsecured.
  • You won’t lose your house if you default.
  • Relatively low fees.
  • Interest paid is not tax-deductible.

Home Equity Loan

  • Can be an installment loan or a revolving line of credit.
  • Secured by your home as collateral.
  • The lender can repossess your house if you default.
  • Expensive closing fees.
  • Interest paid may be tax-deductible.

Personal loans vs. auto loans

If you’re buying a car, a personal loan can give you the benefit of owning your car outright from the get-go. But with an auto loan, you may be able to score a lower interest rate.

WEIGH THE RISKS & BENEFITS

Compare the features of personal loans and auto loans before you make a decision.

Personal Loans

  • Installment loan.
  • Can be secured or unsecured.
  • You won’t lose your vehicle if you default.
  • Typically charge higher interest rates.

Auto Loans

  • Installment loan.
  • Secured by the vehicle as collateral.
  • The lender can repossess the vehicle if you default.
  • Typically charge lower interest rates.

Personal loans vs. student loans

If you’re a college student or looking for a way to consolidate high-interest student loans, you may be restricted to student loans. Even with personal lenders that don’t restrict you from using personal loans for college costs, it may be a good idea to stick with student loans.

That said, student loans are designed to cover education-related costs. So, if you’re looking for a way to finance other expenses, it may be better to use a personal loan.

WEIGH THE RISKS & BENEFITS

Compare the features of personal loans and student loans before you make a decision.

Personal Loans

  • Installment loans.
  • Can use for just about anything, except maybe for education-related costs.
  • Payments start within one or two months after you take out the loan.
  • Don’t provide income-driven repayment plans or loan forgiveness programs.
  • Typically charge higher interest rates.
  • Have short repayment terms.

Student Loans

  • Installment loans.
  • Can use for education-related costs, but not for most other expenses.
  • Provides in-school borrowers with deferment until they leave school.
  • Federal loans come with income-driven repayment plans and loan forgiveness programs.
  • Typically charge lower interest rates.
  • Have long repayment terms.

Personal loans vs. payday and auto title loans

If you have bad credit, some personal lenders charge lower interest rates and offer longer repayment terms than payday and auto title loans. As such, it’s generally better to get a bad credit personal loan.

WEIGH THE RISKS & BENEFITS

Compare the features of personal loans and payday/auto title loans before you make a decision.

Personal Loans

  • Installment loans.
  • Can be secured or unsecured.
  • Repayment periods of one year or longer.
  • You won’t lose your vehicle if you default.
  • Typically charge lower interest rates.

Payday and auto title loans

  • Installment loans.
  • Can be secured or unsecured.
  • Loans are typically due within a couple of weeks to a few months.
  • You may lose your vehicle if you default on an auto title loan.
  • Typically charge astronomical interest rates.

Five reasons to consider a personal loan

Even for borrowers with poor credit, personal loans can be an affordable alternative to payday loans, title loans, and cash advance loans. Never considered a personal loan before? Here are five reasons you should give them a second look.

1. Personal Loans Have a Fixed Interest Rate

Although personal loan interest rates vary depending on how good your credit is, they have the advantage of fixed interest rates. Some loans, think home equity lines of credit and credit cards, change your interest rate depending on an underlying index rate, such as LIBOR or the Wall Street Journal prime interest rate.

A small change in your interest rate can quickly increase your monthly payments, which can mess up your budget in a heartbeat. With personal loans, once the loan agreement is signed, the interest rate does not change for the duration of the loan.

2. Personal Loans Don’t Require Collateral

While unsecured personal loans are not always the cheapest option, they are the safest, at least from the borrower’s perspective. For example, with an auto title loan, you transfer ownership of your vehicle to the lender until the loan is repaid. In the case of pawnshops, you don’t only transfer ownership but also the possession of the security until you repay the loan.

Personal loans, on the other hand, do not require collateral or security. If you fail to repay, the lender will report you to the credit reporting bureaus. However, your bank accounts will not be levied, and you won’t lose your car.

3. Personal loans have fixed installments and a set end date

Unlike credit cards and payday loans, personal loans have fixed payments and a set end date on which the loan is paid. This makes it much easier to stick to a monthly budget. With credit cards, the monthly minimum payment may change depending on the balance on your card; and because it’s so easy to withdraw more and more money until you reach the card’s limit.

4. Personal loans offer better interest rates

Although the interest rates of personal loans vary depending on the borrower’s credit history, they are cheaper than payday loans. This is not always obvious because of the way payday lenders market their loans. Let’s say you borrow $350, pay the $50 fee, and manage to repay the $350 by the end of the two weeks period. The annualized interest rate will be 372.45%, more than double the APR of most personal loans. Keep in mind that most borrowers are stuck paying for a payday loan for much longer than two weeks, which can quickly push the APR rate into four figures. Different personal loans come with different rates, but you can check out the pros and cons of each to ensure that you choose the best personal loan for you.

5. Personal Loans Can Help Rebuild Your Credit History

Most personal loan providers will report your payments to credit bureaus. If you make regular and on-time payments on your personal loan, it can improve your credit score.

Think your credit is not good enough to qualify for a personal loan? You may be surprised. Not all personal loans require excellent or even good credit. Personal loans are a flexible credit option available for borrowers with all types of credit scores.

Are personal loans always the best loan for you? No. Your personal circumstances and preferences determine what the best choice for you is. However, personal loans can offer people who have suffered financial setbacks in the past an affordable source of credit, and a way to rebuild their credit score.

How to get approved for a personal loan

While some lenders design their loans for borrowers with bad credit, that’s not the case with every lender.

So, you’ll want to know your credit score to make sure you have the best chances of getting approved. Based on that score, determine whether it’s best to apply with a lender for bad, fair, good, or excellent credit.

Next, make sure you have a steady income source — you’re unlikely to get approved if you don’t have a job. You’ll also want to ensure you have a good debt-to-income ratio. This means that a relatively low percentage of your monthly income goes toward debt payments.

Many personal lenders allow you to get prequalified before you officially apply. This process allows you to see if you have a good chance of getting approved and, if so, what your interest rate might look like. All of this will be finalized when you officially apply. But it’s good to get some ballpark figures before you commit.

If you’re having a hard time getting approved for a personal loan or you’re afraid you might get denied, consider asking someone with great credit to cosign your loan. Just be sure to pay off the loan on time, or you may damage your relationship.

How to compare personal loan companies

If your heart is set on applying for a personal loan, there are several options from which to choose.

Don’t just accept the first offer. All lenders have their own underwriting standards and guidelines. Even if you’re in a rush, make sure you give another lender a shot if you aren’t happy with the initial rate you were approved for. Interest adds up quickly.

Also, try to get pre-qualified with as many lenders as possible. In fact, SuperMoney’s personal loan engine can help you do this all at once rather than with each lender individually.

The more information you gather during your research, the easier it will be to find the best personal loan for your needs.