If you have a large purchase to make and don’t want to use a credit card to do it, a personal loan is another option you can try. But there are many ways to get a personal loan, and many things to consider before you do. Here are some things you need to know about personal loans is and how they work.
What Is a Personal Loan?
A personal loan can be taken out for just about anything. They are often unsecured, meaning they’re not tied to collateral like a car loan or a mortgage is. However, there are secured personal loans, and you can even use things like your savings account for collateral. The reason you might do this would be to get approved at a better interest rate, but there’s also risk involved. If you default on your loan, you could lose whatever it was that you put up for collateral.
Here are just a few expenses someone might consider using a personal loan for:
- Home improvement projects (if you don’t want to take out a home equity loan or line of credit)
- Large purchases, trips, a wedding
- Debt consolidation
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Conveniently, you can remember what a personal loan is for by thinking about whatever personal expenses you don’t have the cash for. But why would someone choose a loan over using a credit card?
Predictability can be a big factor.
Personal loans are installment loans. That means you’ll know what your interest rate will be (as long as you get a loan with a fixed interest rate). You’ll also know when the loan is scheduled to be paid off. What’s more, most personal loans come with lower interest rates than traditional credit cards. All of this means a personal loan can cost less over the life of your loan than financing your purchase or debt with a credit card.
Some Ways to Get a Personal Loan
There are many places to get a personal loan, from banks and credit unions to online lenders. Just be sure to do your research before choosing.
Some online lenders charge sky-high interest rates, and not all offers come from legitimate lenders. “Advance-Fee Loan” scams, for example, ask you to pay an upfront fee for guaranteed credit approval. You pay the fee and never hear from them again. You can check out some of the warning signs to watch for in this list from the Federal Trade Commission.
Here are a few more things to keep in mind when shopping for a personal loan:
- Know how much you need to borrow – borrowing more than you need only costs you more in interest over the life of your loan
- Compare fees being charged by different lenders — from origination fees to late fees — and find out if they charge a fee for paying off the loan early (called a prepayment fee)
- Variable rate loans will have lower interest rates, but they can end up costing you more since the rates (and thus your monthly payments) can go up
- Look at lender reviews — since you might end up working with a lender that’s new to you, you’ll want to know that they’re reliable and easy to work with
- You can apply for several loans at once to try to get the best offer you can get without hurting your credit, but you should understand how multiple applications can affect your credit score and consider these tips for rate shopping
Finally, if your credit isn’t strong enough to be approved, or you can only get approved with sky-high interest rates, you could ask someone to cosign for you. However, be aware of the fact that if you were to default on the loan or even make a late payment, your cosigner’s credit could be negatively affected.
Things to Consider Before Taking Out a Personal Loan
Before using financing to pay for anything, it’s important to understand how much interest can cost you. If you take out a $10,000 loan to pay for home improvements, for example, it would be inaccurate to say that your home improvements cost you $10,000. Instead, they cost you that amount plus whatever you pay in interest and fees over the life of the loan.
According to Experian, the average personal loan interest rate as of Fall 2018 was approximately 17 percent. Let’s say, for example, that you’re approved for a $10,000 personal loan at a lower fixed rate of 10 percent. Using this calculator from SmartAsset, here’s what you’d pay:
- For a three-year term, you’d pay $11,616 in total — that’s $1,616 in interest added to your original balance
- For a five-year term, you’d pay $12,748 in total — meaning that you’d pay an extra $2,748 after the original borrowed amount of $10,000
As you can see from these examples, interest is no small cost. Therefore, it’s important to look carefully at the interest rates you’re being offered and understand that a longer-term loan could cost you more in interest, even if it lowers your monthly payments.
All that said, the better your credit is when you apply for the loan, the lower the interest rate you’ll likely be approved for, which minimizes the cost of the personal loan in general. If your credit needs work and you can wait on the purchase, it might be helpful to start working on it using these steps to improve your credit.
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