Should I get a personal loan?
Personal loans can provide much-needed funds
A personal loan provides funds that can be used for nearly anything, including home renovations, debt consolidation, car repairs, vacations, weddings, emergency cash and starting or supporting a small business. Personal loans may be unsecured, which means the lender doesn't require collateral, or secured, requiring the borrower to put up an asset like a car.
Reasons to get a personal loan
A personal loan makes sense in many situations. With a personal loan, you pay a predetermined annual percentage rate (APR) for access to funds. Lenders charge interest and other fees, including origination fees, to cover the processing of the loan.
After taking out a personal loan, you make regular monthly payments to the lender until the loan is paid back in full. Many lenders report payment activity to the three main credit bureaus, so getting a personal loan may also help you build good credit if you make payments on time each month.
Borrowers can typically use a personal loan for any reason, including:
- Consolidation of high-interest debt
- Purchase of a car, RV, boat or motorcycle
- Emergency home or car repairs
- Home renovations
- Small business expenses
- Funeral or celebration of life and related expenses
Personal loans typically have lower interest rates than credit cards, so they often make sense when you need to make a significant purchase immediately.
Things to consider when taking out a personal loan
Getting a personal loan may solve a short-term problem, but it's important to remember that payments may stretch out for years into the future. Before considering a personal loan, take a close look at your current financial situation and decide whether you could reliably handle monthly payments for the next few years.
Missing even one monthly payment could result in hefty late fees. Late payments reported by the lender to the credit bureaus could drop your FICO credit score and restrict your access to credit in the future.
If you have unreliable income, aren't sure you have room in your budget for monthly payments or don't need the funds for an immediate purchase, it might be best to save the money you need over time instead of taking out a personal loan.
How to qualify for a personal loan
Lenders typically look closely at your financial situation when deciding whether to approve your application for a personal loan. Your credit rating has a direct effect on your loan's annual percentage rate (APR), which is the annual cost of the loan, including interest and fees, expressed as a percentage of the amount borrowed.
Lenders ask for documents and information before approving your loan. These can include:
- Proof of employment: Lenders may want to see copies of your most recent pay stubs and a letter from your employer proving that you have a steady job.
- Tax returns: You may have to provide a copy of your tax returns to show that you have a reliable income that's large enough to afford the monthly payments for your loan.
- Other income sources: If you have investment income, earn money from a pension or receive Social Security benefits, you may have to provide proof of that income.
- Evidence of savings and cash: Lenders want reassurance that you have additional funds available to help you make monthly loan payments if your income decreases. They may ask you for recent bank statements showing that you have money set aside for emergencies.
Lenders look at your credit history to determine whether you have a record of making on-time loan payments. Borrowers with higher credit scores generally have an easier time getting approved for personal loans.
FICO credit scores range from 300 to 850, with higher scores indicating a reduced risk of default. Borrowers with credit scores in at least the "good” range (670 or higher) and higher may qualify for personal loans with favorable terms more easily than those with credit in the "fair" or "poor" range (669 or lower).
Some lenders will not approve applicants with low FICO credit scores, no matter their income, employment or evidence of savings.
Here are the credit score classifications, according to Equifax:
- 300 to 579: Poor
- 580 to 669: Fair
- 670 to 739: Good
- 740 to 799: Very good
- 800 to 850: Exceptional
When a personal loan isn't right
If you're short on cash, a personal loan may not be the best solution. If low earnings are negatively affecting your ability to pay bills and establish an emergency fund, a personal loan may provide a short-term answer that could make your financial problems worse in the long run.
Taking out a high-interest personal loan for an unnecessary expense could make your financial problems worse.
Borrowers with low credit scores or who have defaulted on loans in the past may have a tough time getting approved for a personal loan. If the interest rate and fees are too high, it may make more sense to take time to improve your credit score.
Using a personal loan for unnecessary expenses could harm your future financial health. For example, if you take out a personal loan to fund a vacation and get sick six months later, you may experience a reduction in your income that makes it difficult to make your monthly payments on time.
When your loan payments are late, the borrower may report the negative activity to credit bureaus, which will cause your credit score to drop. When you need to get a car loan or refinance your mortgage, your options may be limited due to your credit status.
- What can a personal loan be used for?
You can use a personal loan for any purpose, including vacations, home renovations, debt consolidation or large purchases such as a car, boat or motorcycle.
- What is a good reason to take out a personal loan?
If you have high-interest credit card debt with multiple credit card companies, a personal loan can help you pay off that debt and save money on interest charges. Personal loans are also used to purchase cars, pay for necessary home repairs or fund a wedding.
- What credit score do you need for a personal loan?
Lenders may disclose their minimum credit score requirements upfront. In general, lower credit scores mean higher interest rates and fees. Expect to see minimum score requirements in the 600 to 650 range for most personal loans with average interest rates.
- What are the different types of personal loans?
There are many different types of personal loans, and the right one for you may vary depending on your situation and how you intend to use the funds. Some types of loans, including auto loans and mortgages, require collateral, while others are unsecured. Loans may also have fixed or variable rates.
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