If you’re thinking about getting a personal loan, you may have some questions. And, odds are, you’ve heard some things about the process that might not really be true. So, what’s the reality of personal loans? And what do many people believe that’s not truly accurate?
We’re breaking down six of the most common myths when it comes to personal loans and sharing the truth of the lending process.
If you’ve ever applied for a mortgage or a student loan, you know how involved that process can be. But completing an application for a personal loan is usually a much simpler endeavor. Nowadays, most lenders offer a secured online portal for applications. So, you can complete the required forms, upload supporting documentation, and submit your application in one sitting, right at home. Those documents typically include proof of income, details on existing loans, a form of identification, and evidence of housing costs. From there, you simply wait. Lenders typically approve and disburse funds within two weeks, but some provide financing in as little as 24 hours.
Often, a personal loan does translate to additional debt in your name. But a personal loan can frequently be a smart choice when compared to other types of financing. Credit cards offer convenience, but sometimes have low limits. And payday lenders can charge as much as 400% interest on money borrowed. So, a personal loan might offer you the financing you need at terms that make the most financial sense for you.
Furthermore, you might be using your loan to consolidate debt. That is, you use the funds from your new personal loan to pay off existing loans, credit cards, or lines of credit. Instead of paying multiple lenders each month, you pay one — the institution through which you received your personal loan. So, when you consolidate your debt, you’re not actually taking on more debt. In reality, you’re transforming the debt you have into a new loan. And that loan may even offer the advantage of a lower interest rate and a shorter repayment period.
It’s true that, to qualify for a traditional personal loan, you generally need a credit score of at least 670. But you have an option you may not have realized if you fall below that mark. It’s called a bad credit loan — a unique type of personal loan available specifically to people with less-than-average credit scores.
Like other personal loans, bad credit loans usually come in the form of unsecured installment loans. You receive the funds without needing to put down any collateral for the loan. Then, you repay the balance in equal monthly installments until the term of your loan expires. Some banks and credit unions may offer bad credit loans. But you can also apply with a dedicated lender that specializes in offering loans to those with less than prime credit.
A number of factors affect the health of your credit score. With the most popularly used scores, payment history carries the most weight. But applications for new credit do figure somewhat into the calculation of your score. Whenever you submit an application for new credit, your financial institution runs a hard credit inquiry. That inquiry will appear on your credit report and remain there for up to two years.
Fortunately, the hit to your credit score is minimal. At most, your score might dip five points. And, usually within a few months, that drop will lessen and go to zero. Plus, most modern credit scoring models give you an allowance for “rate shopping.” So, if you apply with multiple personal lenders within a short period of time, that set of applications will count as just one hard inquiry.
Best of all, you can actually take steps to limit those hard inquiries upfront. Before applying for a loan, go through your lender’s prequalification process. It’s less involved than a full application, and it gives you insight into the type of loan for which you might qualify. And there’s no hard credit check. So, you can comparison shop through prequalification without any impact to your credit score.
Your mortgage is one type of secured loan. If you fall far enough behind on payment, your lender can start the foreclosure process and may seize your home.
With personal loans, there’s no collateral on the line. These loans tend to be unsecured, meaning your lender can’t simply seize a particular asset to cover its losses. That doesn’t mean that failing to pay is consequence-free. If your loan goes into default, your lender still has legal options to recoup the funds lent to you and it could damage your credit score. Generally, your account will first go to collections. You’ll get calls and letters from a dedicated business team working with the lending financial institution. If you remain in default, you might be sued for the amount you owe.
If your lender or the collections agency wins in court, the judge can grant an order allowing your creditor to garnish your wages or grant your creditor a lien on one of your assets.
When you have an installment loan, your payment schedule is usually fixed. You send out the same amount every month until your debt goes to zero. But what if you’re able to pay more than that? Maybe you get a one-time influx of cash, or you’re able to up your payment amount every month.
Paying ahead of schedule has its benefits. You can get out of debt sooner and pay less interest in the long run. But some lenders charge a prepayment penalty — slapping you with a fee for prepaying part or all of your loan. So, saving money on interest still means paying extra.
Fortunately, not every loan and not every lender penalizes you this way. Before you commit to a new personal loan, read the terms of your financing. And look for lenders who offer personal loans without those costly fees.
Getting a personal loan doesn’t have to be confusing. With the right information about how these loans work, you’re better positioned to make great decisions for your financial future. And you can choose your new personal loan with confidence.