The Basics of Personal Loans
They're not like credit cards, and qualifying for them can be more difficult
Personal loans are general purpose loans. You usually can use the funds at your discretion, but some lenders will restrict what you do with the money. They're often more difficult to get than credit cards and sometimes come with their own specific rules.
Because personal loans can be used for just about anything, there's no single reason why consumers might seek them. Typically, such loans are an option for purchases or other expenses that are too much to put on a credit card. Some common reasons include:
- Unexpected expenses: A major home repair or a need to replace expensive appliances—such as a furnace—could be too much for your credit card, and you might look into a personal loan to cover the cost. Medical expenses are another unexpected cost that might require a personal loan.
- Major events: You might want to pay for a significant event, such as a wedding, but you just don't have sufficient savings on hand to pull it off. Expenses beyond what you have in your savings can be covered by a personal loan. Other major events that might prompt a personal loan are funerals or a move to a new location.
- Debt consolidation: The proceeds can be used to pay off credit cards or other debts. You'll have only one monthly payment, and you might find that your loan's interest rate is lower than the average interest rate for your other debts.
- College: A personal loan might have a better interest rate than a federal student loan, or your income might be too high to qualify for such a loan. However, personal loans don't come with the same tax advantages as federally recognized student loans. Check with a tax professional first to make sure you don't get dinged at tax time.
The loan is unsecured, which means you're not required to place an asset as collateral when you borrow. The lender can't automatically take a piece of your property as payment if you default. This is one of the reasons personal loans are more difficult to get.
However, personal loan lenders can take other collection actions even if they can't automatically take your house, car, or other assets. These include reporting late payments to credit bureaus, hiring a collection agency, or filing a lawsuit against you.
The amounts of personal loans typically range anywhere from $1,000 to $50,000, depending on your lender, your income, your other debt, and your credit score. The better your credit score and the higher your income, the more money you can borrow.
Most banks place caps on the amount you can borrow. For example, you might be able to borrow a maximum of only $10,000 even if you're a highly qualified borrower with an excellent income, if the lender's policy is to offer no more than that.
You can't borrow from the loan over and over the way you can with a revolving credit card balance. Payments toward the loan reduce the balance, but they do not open up more available credit that you can borrow again. The account is closed when you pay off the loan. You'd have to reapply if you wanted to borrow again.
Interest and Fees
The interest rate on a personal loan usually is locked, which means it does not change for the life of the loan. However, some personal loans do have variable interest rates that change periodically. The drawback of a variable interest rate is that your payments can fluctuate as your rate changes, making it harder to budget for your loan payments.
Interest rates on loans are based on your credit score. Generally, the better your credit score, the lower your interest rate. In addition to charging interest, lenders will charge late fees if your payments fall behind. Many also charge origination fees to set up the loan. These can run from about 1% to 6% of the amount you're borrowing and depend on your credit score.
You'll have a set period of time to repay your personal loan—usually 12, 24, 36, 48, or 60 months. Longer repayment periods lower your monthly loan payments, but you'll also pay more in interest than if you had a shorter repayment period. Your interest rate also can be tied to your repayment period as well. Shorter repayment periods typically result in lower interest rates.
Having an open loan can affect your ability to get approved for other loans or credit cards, so longer repayment periods might limit future options for obtaining credit. Many personal loans also have penalties for paying off the debt early, so it's best to take the shortest repayment period you can afford.
It might be easier to get a personal loan from a bank or credit union where you already have a relationship. The bank probably will want to know what you're going to use the money for and might even have a better loan for your needs.
As with any other loan, choose your personal loans wisely and borrow only what you can afford to repay. Take time to calculate what your monthly payments will be so that you're sure you can incorporate those payments into your budget. Compare rates before settling on a lender. You might want to borrow less or give your credit score some time to improve if you're being offered money at high interest rates.
Loan details are reported to credit bureaus and become part of your credit report, like any other loan. The inquiry into your credit impacts your score as does making timely payments and reducing your loan balance.
Common Rates and Terms
A multitude of lenders offer personal loans, and terms and conditions can vary significantly between them. Banks and credit unions tend to offer good rates, but some online lenders offer even better terms, particularly to those with very good credit. Online lenders can also be more forgiving of poor credit.
As of 2019, some of the more popular and reputable lenders include:
- Avant: Borrow up to $35,000 and apply online so you'll know within minutes if you've been approved. Your loan can be funded within 24 hours. Rates range from 9.95% to 35.99%, depending on the terms and your credit history. Loan terms range from 24-60 months, and they charge an administration fee up to 4.75% of the amount of the loan.
- LendingClub: Personal loans with flexible terms are available from $1,000 to $40,000, and you can apply online. This is a peer-to-peer lender, not a bank.
- LendingPoint: Approval likely for those with credit scores of at least 585, and they consider merit-based qualifications, such as employment history and the amount of debt you're currently carrying. Borrow up to $25,000.
- LightStream: They market themselves to borrowers with good credit histories, offer reasonable rates, and do not charge an origination fee. It doesn't allow you to borrow to pay off student loans, however. You can borrow as much as $100,000 for a term of up to 144 months.
- Upgrade: This company offers loans of up to $50,000, funded within 24 hours. Loan terms range from 24-60 months with interest rates ranging from 7.99%-35.89% and origination fees ranging from 1.5%-6%.
Watch out for loan scams, particularly if you're shopping for a lender who'll approve you with a bad credit history. Avoid any lender that guarantees approval without first checking your credit or that asks you to send money—especially via wire transfer or prepaid card—to secure the loan. You always can check with the Better Business Bureau or the Consumer Financial Protection Bureau if you're unsure.