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A personal loan is a type of loan that allows flexible use, short- to moderate-term repayment options and relatively quick funding. Whether you're trying to consolidate high interest debt, start a business or pay an expensive medical bill, a personal loan can help you accomplish your goal.
But a personal loan can be expensive compared with other types of debt, and it may not be the best option for every situation. Here's what to consider before you apply.
What Is a Personal Loan Used For?
In most cases, personal loans are unsecured, which means you don't need to put up collateral to get approved. There are, however, secured personal loans, which require you to use a savings account or another asset as collateral in case you default.
Personal loans typically come with fixed or variable interest rates, as well as repayment terms that range from just a few months to up to seven years—though some can go longer.
With most lenders, you have a lot of leeway for how you can use your personal loan funds. That includes things like:
- Debt consolidation (especially for credit card debt)
- Medical bills
- Home repairs and renovations
- Repaying family or friends
- Wedding expenses
- Divorce costs
- Moving expenses
- Funeral costs
- Furniture or appliance purchases
- Small business expenses
- Holiday shopping
Keep in mind, though, that some lenders may have restrictions on how you can use your money. Some may prohibit education-related expenses, for instance. Check with the lender beforehand to make sure you can use a personal loan for your intended purpose.
When Is a Personal Loan a Good Idea?
While it's possible to use a personal loan for just about anything, that doesn't mean it's always wise to do so. In general, it's a good idea to use a personal loan when it can improve your financial situation or provide necessary funds. Examples include:
- Debt consolidation: If you have high interest credit card debt, you may be able to save money by paying it off with a lower interest personal loan. Even if you don't necessarily save money on interest, a personal loan can provide a structured repayment term, which can help if you're struggling to stay motivated in paying off your debt.
- Home renovations: If you want to make some improvements to your home, a personal loan may be a better choice than a home equity loan or line of credit because it doesn't come with the threat of losing your home if you default.
- Emergency expenses: In an ideal world, you'd have enough money set aside for emergencies. But life isn't always ideal, and if you lose your job, your car breaks down or a major home appliance needs to be repaired or replaced, a personal loan can provide some peace of mind at a stressful time.
- Personal events: Weddings, divorce and funerals can be expensive, and it's not always possible to save up for such a major life event. In these instances, a personal loan can provide much-needed funds at the right time.
While it's possible to use a personal loan for things like vacations and expensive consumer goods, it's best to save up until you can pay for these expenses with cash (or charge them on a credit card to get the points and then pay them off immediately).
How to Compare Personal Loans
Just as with any other financial product, it's important to shop around and compare several personal loan options before applying for one. Even if you get an offer from your primary bank or credit union, it's possible you could find a better deal elsewhere.
Here are the different features to consider while you're comparing personal loans:
- Interest rate: A loan's interest rate represents the cost of borrowing money. The average personal loan interest rate is 9.41%, according to Experian data. However, your rate offers may be higher or lower based on your credit and financial situation.
- Loan term: Different lenders offer varying repayment terms, and how long you have to repay a debt impacts your monthly payment. If one offers you three years to repay a debt and another offers only two years, your monthly payment could be significantly higher with the second option—but you might also save on interest with the shorter-term loan.
- Fees: In addition to interest, some lenders charge fees that could increase your annual percentage rate (APR). Origination fees, for instance, are deducted from your loan funds before you receive them, and some lenders also charge late fees and prepayment fees if you pay off your loan early.
- Funding time: Some lenders offer next-day or even same-day funding, while others can take several days to deposit the funds into your checking account. Depending on how soon you need the money, consider these timelines.
- Other features: Not all lenders provide added features, but some may allow you to get a lower interest rate if you set up automatic payments or have an existing relationship with the bank. Others may offer forbearance options if you lose your job.
Many personal lenders allow you to get prequalified with a rate offer before you officially apply. This process typically requires a soft credit check, which won't impact your credit score. This process can allow you to compare loan options side by side and pick the best fit for you.
How to Qualify for a Personal Loan
Personal loans are available for most consumers across the credit spectrum, but there are some things you can do to improve your chances of getting approved at a favorable rate. Here are some factors lenders consider when you apply:
- Credit score: Your credit score is a snapshot of your overall credit history, and the higher it is, the better your chances of getting approved with a low interest rate. That said, there are personal loans for bad credit, so you're not completely out of luck if you don't have time to improve your credit before you apply.
- Income: Your ability to repay the debt is another major factor, and lenders will specifically consider your debt-to-income ratio—that's how much of your gross monthly income goes toward debt payments. A low ratio means you're more likely to be able to afford your loan payments because there aren't too many competing debts.
- Credit report: While your credit score is important, lenders will also check your credit report to make sure there aren't any negative items from the past that could affect their decision. Specifically, things like delinquent payments, collection accounts, bankruptcy and foreclosure could act as a red flag and make it difficult to get approved.
If your credit and income situation isn't where you want it to be for a personal loan, work to improve it before you apply.
Start by checking your credit report to pinpoint areas you need to address, and also work on paying down debt to reduce your debt-to-income ratio. This process can take time, but it can save you a significant amount of money if it can help you qualify for a lower interest rate.
Do Your Homework
A personal loan can help you cover necessary expenses and improve your debt situation. But it's important to consider both the benefits and drawbacks before you apply. It's also essential that you take the time to shop around and compare different options before applying for one.
As you research lenders, check out Experian CreditMatch™, which can provide loan offers from multiple lenders in one place with just a few details from you. This can help you save time as you research and narrow down your list of potential lenders.