If you need money but don’t have friends or family willing to lend you cash or credit cards, your options may be somewhat limited. A pawn shop will lend or pay you pennies on the dollar for family heirlooms or high-tech electronics.
If you don’t have any collateral to offer a lender, there are other options for personal loans as well. Payday loans may be easy to obtain, but you could literally spend month after month making payments without ever really making a dent in what you owe.
Under such circumstances, a personal loan may represent your best hope for getting the money you need. But if your credit is marginal, obtaining a personal loan can be a challenge. Even if you qualify, the interest rates will probably be steep, and depending on the type of loan you obtain, the initial interest rate of your loan may not be the rate that you pay throughout the life of the loan.
Factors That Affect Loan Rates
Along with your personal credit profile, differences in the polices applied by lending institutions can have a profound effect on loan rates – as well as what the final cost ends up being to pay off a personal loan in full. In general, smaller community banks and credit unions will charge lower interest rates for all types of loans – including personal loans – than large corporate institutions. You may also find that credit unions are more flexible in applying credit standards to borrowers than conventional banks.
Lenders that require borrowers to pay points typically charge lower interest rates than lenders that do not require points. Points represent up-front payments required by some lenders in exchange for lower interest rates. Each point represents a single percentage point of the principle of the loan. For instance, for a $10,000 loan, each point would be equal to $100. If you can muster the extra cash to pay points up front, a loan with points could be an attractive alternative, due to the lower resulting principle.
Finally, you should consider the annual percentage rate – the APR – for your loan. The APR for loans is typically calculated by including some or all of the extra costs along with the principle, including origination fees, points or other processing fees. Inquire with potential lenders about which fees, if any, are included along with the principle in calculating the APR. The interest rates and total costs of a personal loan with an APR that includes additional fees can be significantly higher than the interest rate and total costs of a personal loan where the APR does not include such fees.
With Loan Rates, Fixed is Better Than Adjustable
You may appreciate and even insist on flexibility in other areas of your life. But where loan interest rates are concerned, fixed-rate loans are frequently more desirable than adjustable-rate loans. This is because fixed rate loans are exactly what their name implies – loans for which the interest rate is set at the beginning of the loan term, and for which the interest rate remains consistent throughout the entire life of the loan. With a fixed rate loan, you can calculate your total payments at the beginning of the loan term. If you make extra payments, you can easily rack up significant savings and end up paying the loan off sooner than expected.
By contrast, adjustable rate loans carry initial interest rates that apply only for a specific period of time, after which the interest rates may rise or fall. Of course, if you contract for an adjustable rate loan during a period when interest rates are low or even decreasing, such loans can save you a significant amount of money over a fixed rate loan of a similar amount. But if interest rates rise – so do your loan payments as well as the total amount that you eventually must pay for the loan.
Also with adjustable rate loans, it is much more difficult to plot a strategy to pay off your loan early. This is because it is difficult predicting what changes may occur with your interest rates down the line, so you aren’t really able to calculate what your total payments will be throughout the life of the loan.
Full Faith and Credit of Conventional Loans
Whether you opt for a fixed-rate or adjustable-rate, Conventional Loans are considered to be a type of installment credit. With a conventional loan, you receive the funds upfront and repay the loan in installments over time. In exchange for obtaining more time to repay your loan, you pay interest to the bank or other lender, which raises your total repayments above the initial amount of the loan. Once you make the final installment payment, your loan account is closed.
The criteria applied by lenders for most traditional loans are stiff. Bankers and other lenders impose stringent credit and underwriting standards to ensure that a potential borrower is creditworthy. Along with a tough underwriting process, lenders frequently demand borrowers to present collateral that is worth as much or more than the amount of the potential loans. The bank or lender typically places a lien or hold against the collateral until the loan is paid in full, after that any liens or holds are released.
Collateral represents a type of security that guarantees the lenders will be able to recover their investment even if borrowers are unable to repay their loans or simply refuse to do so. By seizing the collateral, the bank or lending institution can close the books on a bad loan. Along with stringent credit underwriting, the presence of collateral represents the main reason that interest rates for houses and even cars are lower than interest rates for credit cards or personal loans – neither of which provide collateral.
Personal Loans — Sign on the Dotted Line
Like conventional loans, personal loans represent a type of installment credit. But personal loans differ from conventional loans in one important aspect – there is no collateral. In this respect, they are similar to credit cards or an unsecured line of credit, neither of which require collateral.
The main factor driving the high rates that personal loans carry is the nature of personal loans. Also known as signature loans, personal loans basically represent your promise to repay the money that you receive in a timely fashion. If you have demonstrated reliability with past financial obligations in the form of a good or excellent credit profile, lenders are more likely to believe that you will make good on your promise to repay a personal loan. As a result, you are likely to be approved for a personal loan at a favorable interest rate, although likely higher than the interest rate for a conventional loan.
In contrast, if your credit record is spotty or littered with charge offs and late payments, lenders will understandably be more hesitant to accept your promise to pay. As a result, you will be less likely to obtain approval for a personal loan. If you are fortunate enough to find a lender willing to approve a loan for you, make no mistake — it’ll cost you.
Around and Around She Goes
Personal loans and credit cards are each considered to be unsecured credit, for which banks and lending institutions typically charge higher interest rates than for secured loans. The interest rates charged by creditors and lending institutions for both personal loans and credit cards can be quite high – well into double digits. Nonetheless, all other factors being equal, if you have the choice between taking a personal loan and taking a cash advance against a credit card, you’d be better off taking the loan.
Unless you have excellent credit and qualify for special low-interest or zero-interest credit cards, you will typically pay higher interest rates for credit cards than you would pay for most loans. As a result, even if you are able to obtain the same amount from a cash advance as you could receive from a personal loan, unless you repay the entire amount immediately, you will likely pay a much higher total for a credit card cash advance than for a personal loan. This is because credit cards are a type of revolving credit. The revolving nature of credit cards makes them a poor alternative for obtaining cash.
With a revolving credit line, as you make purchases, your available credit decreases. But when you make payments, your credit is replenished, which makes funds available to you again. In this respect, credit cards can be extremely convenient for making purchases when you don’t have cash on hand.
But the convenience of credit cards can become a trap where cash advances are concerned. Unless a credit card balance is paid off in full immediately, each payment that you make only covers a portion of the principle – the rest is applied to interest, which increases the total amount that you pay in the long run. Conceivably, you could make on-time monthly payments on your credit card indefinitely, while making little or no dent in the actual principle that you owe.
You Better Shop Around
It is definitely worth your while to shop around for the best possible loan terms, especially if you intend to borrow a significant amount of money. Don’t be afraid to ask questions to ensure you have accurate information on hand concerning fees, credit underwriting standards and other aspects about prospective loans. After all, making the wrong choice can ultimately result in your being required to pay hundreds, if not thousands more for your loan than you should.
Audrey Henderson is a Chicagoland-based writer and researcher. She holds advanced degrees in sociology and law from Northwestern University. Her writing specialties are sustainable development in the built environment, policy related to arts and popular culture, socially and ecologically responsible travel, civic tech and personal finance.