Maybe you’re ready to achieve your childhood dream of driving across the country. Or, perhaps, you’re simply looking for a little extra cash to help ease you out of a tight spot. Whatever the situation, cash flow is undoubtedly important. And sometimes, a personal loan might be just what you need to make things happen.
Simply put, a personal loan is money that’s borrowed for any personal purpose. It’s a loan that you can spend however you’d like.
Personal loans are commonly used to cover medical emergencies, refinance student loans, consolidate credit card debt, pay for weddings, make large purchases, and much more. These types of loans are often attractive because they tend to be unsecured, meaning they don’t require collateral (valuable assets) that a lender can claim should you be unable to repay.
It’s important to understand, however, that obtaining a personal loan is far from simply asking a friend to spot you some cash. There are many factors you should be aware of before applying for a personal loan.
Here, we’ll take a look at what goes into getting a personal loan, as well as how to find the right loan for your unique wants and needs.
There are a few things you’ll need to figure out before applying for a personal loan, including:
Different projects, goals, and circumstances require different expenses. You’ll need to determine the principal amount you need to borrow to cover your costs.
It’s important that the number you come up with is as realistic and informed as possible. While having a little wiggle room is acceptable, there’s no reason to pay interest on money you don’t really need. If you don’t borrow enough, however, you may end up needing to apply for another loan at the last minute. This will increase your monthly interest payments—a portion of which could've been avoided in the first place.
It’s common for lenders to have non-negotiable criteria for eligibility. These may include your credit score, the quality of your credit history, or a minimum income.
Visit a lender’s website or give them a call to check whether you meet their specific requirements. Doing so can save a lot of time—and disappointment—in the long run. If you don’t meet a lender’s qualifications right now, do your best to improve the factors you can control (such as your credit score and debt management) before re-applying.
One of the biggest determining factors that lenders consider is your creditworthiness. In short, this refers to the likelihood that you’ll pay back money that you’ve borrowed.
Both your creditworthiness and your loan terms are largely dictated by your credit score, as well as up-to-date credit reports from each of the three major credit reporting agencies (Equifax, Experian, and TransUnion). Generally, the more creditworthy you are, the better terms and conditions you’ll get on a personal loan. Being creditworthy also means you’ll have more bargaining power in negotiating for a better deal.
Tip: You can get your scores and reports once a year for free from AnnualCreditReport.com. This action (known as a soft inquiry) won't affect your credit score (and some lenders even do this for you).
The types of places that offer personal loans are primarily distinguished by whether or not they have a banking license. Each type of lender has its own unique pros, cons, and application process.
Banks and credit unions are the go-to places for most people looking for personal loans. One perk is that neither typically charges loan origination fees, unlike other sources for personal loans.
When you apply for a personal loan at a bank or credit union, you’ll meet with a loan officer. He or she will explain the requirements and guide you through the application process.
Banks tend to have stringent standards when it comes to loans, but you may get a deal if you’re already their client. Credit unions, on the other hand, aren’t as rigid as banks (and usually offer lower interest rates). However, you have to be a member of a credit union in order to take advantage of its services.
NBFCs, which include online and brick-and-mortar finance companies, peer-to-peer (P2P) lenders, payday lenders, and even insurance companies, may approve your application for a personal loan when a bank won’t.
These institutions, however, have different regulations than banks and credit unions do. Do your research on their application process, interest rates, and fees before you apply.
Now that you’ve determined that you’re eligible for a loan, you’ll want to take a look at the following information in your pre-approval letter, as well as on the lender’s brochures or website.
Expected Loan Amount, Annual Percentage Rate (APR), Monthly Payment, and Loan Term: Some lenders may offer you different terms and amounts. It’s a good idea to compare figures from different lenders.
Type of Interest: There are two types of interest: Fixed and variable. A fixed interest rate stays the same for the duration of the loan, while a variable interest rate may increase or decrease, affecting the total amount of interest you’ll pay.
Unsecured or Secured: Determine whether the loan you’ll receive will be secured or unsecured. For common secured personal loans, such as mortgages and car loans, lenders will ask you about the asset you’ll be using as collateral.
Fees and Penalties: You may have to pay an origination fee (which typically ranges from 1% to 6% of your principal). You should also keep an eye out for penalties (such as late and missed payment fees) and other charges.
Prepayment Penalty: In some cases, lenders will require you to stick to their predetermined timeline, penalizing you if you pay back the loan in full before its due date (called a prepayment penalty).
Automatic Withdrawal: This arrangement allows you to make your payments automatically by withdrawing from either a credit card, a checking account, or a savings account. Automating your payments means avoiding late or missed payment fees.
Required documentation: Most lenders require at least proof of income (pay stubs, W2 forms), a valid ID, and your Social Security number.
Fine Print: It’s important that you read every document you agree to from top to bottom. The fine print may hold information to help resolve unanswered questions (or even deter you from agreeing to a predatory loan).
After weeding out the loans that aren’t suitable for you, start to focus on the lenders who are most likely going to approve you for a loan. Many lenders even offer pre-qualification or pre-approval—all that’s typically required is filling out a form with your name, address, income, and desired principal amount.
Just remember that this process doesn’t guarantee that you’ll be approved. Instead, it means that your financial profile has made you eligible to move on to the next step in the application process.
When looking for a personal loan, it’s important that you do your due diligence. Doing plenty of research will help you determine which loan option is best for you. The right loan—combined with good financial habits—can improve your financial well-being and open up more (and better) opportunities for you in the future.