Why Take Out a Personal Loan?
A personal loan is quite often used to refinance existing debts, although they are a bit different to debt consolidation. Debt consolidation consists of paying off the loans through a new loan and bundling them all together.
When using a personal loan for debt, the bank or lending institution gives the consumer a requested amount of money and allows them to spend it as they need.
However, personal loans aren't just for debt consolidation. These types of loans can be used for anything from helping to start a small business or to help fund your remodeling project.
What Can You Use a Personal Loan For?
People take out personal loans for a number of reasons. Here are a few comparisons we've done highlighting the differences between personal loans and other types of loans or financial solutions:
Another common use for a personal loan might be home renovation or perhaps even vacations. In short, a personal loan is a lender offering you money to do what you wish with it.
Who Offers Personal Loans?
Traditional banks offer personal loans, as well as a whole plethora of online institutions. In fact, these days, it is much more common to get a personal loan online than it is through a traditional bank, as the lending requirements are typically more lenient.
While the process is easier with online lenders, there are still a few things you need to consider before you apply for a personal loan. Lenders will look at a number of factors that will determine the amount of the loan and the rates that you qualify for. Make sure you give yourself the best chance to get a personal loan by filling out your application the right way.
The Process of Qualifying for Personal Loans
Obviously, lenders will have varying standards, but in general, they all work within a wide framework. The most obvious part of qualifying is your credit history. The higher your credit score, the more likely you are to get financed.
Someone with a credit score of 500, is going to have a much harder time getting a personal loan than somebody with a credit score of 795. Beyond that, the higher the credit score, the more likely you are to have a favorable interest rate. It comes down to credit risk for the lender.
The lenders will often ask for pay stubs or employment information, as well as your Social Security number to prevent fraud.
Sometimes, personal references will also be used as well, but in the end, lenders put very little faith in those, because quite frankly, you can get two of your buddies to tell them whatever you want. If your credit isn’t that great, quite often, the lenders will ask for a cosigner.
Keep in mind that a cosigner is responsible for the debt just as you are, so if you default, you are very likely to destroy a friendship or relationship. Cosigning can help, but it should be a last resort.
In addition, you can often secure a personal loan with some type of collateral. If you are a homeowner, you are much more likely to get financed even with bad credit because the lender can take possession of the real estate to recoup their losses.
Ultimately, there are other forms of collateral that are used, such as automobiles and boats, but hopefully, you won’t have to use (or possibly lose) these valuable assets as collateral. If your credit score is high enough, this shouldn’t be an issue.
Remember that lenders are businesses, such as any others, meaning that some will offer different products to others. Beyond that, there are interest rate differentials and penalties that you should be paying attention to.
Some lenders are much more generous as to who they will lend to, and they specialize in lending to people who are a higher credit risk. By doing so, they need to recoup losses from those who default, and typically they do this by charging more in fees to those who do pay the loans off.
With this in mind, it’s paramount that you look around and see who offers the best interest rate as well as the least amount of fees, such as origination fees, late payment, or even prepayment penalties.
Never rush into a personal loan and take any money that is offered to you before you compare personal loan rates.
Savings Versus Personal Loans
Obviously, if you find yourself in a financial mess, if you have savings put away, it’s easy to use them to pay off the debts. In a perfect world, you will have six months of savings for just this situation.
Unfortunately, most people don’t have savings anymore, so this is where personal loans, and the like, come into play.
Keep in mind that savings don’t cost you interest, so in the end, it’s a much cheaper option. If you do find yourself in a situation where you are going to take out a personal loan, you should make it a goal to start saving as you pay off the loan, in order to avoid having to borrow again.
While personal loans come with their pros and cons, in the end, they can be a bit of a financial lifeline when needed.