A personal loan is a form of credit that allows consumers to finance large purchases, such as an appliance or another big-ticket item, or consolidate high-interest debt from other products like credit cards.
In most cases, personal loans offer lower interest rates than credit cards, giving consumers the ability to consolidate their debts into one lower monthly payment.
Interest Rates for Personal Loans
Personal loans can often boast lower interest rates than credit cards, which average 17.31% as of this writing (9/19/2018). Like other types of debt, the interest rates for personal loans depend on the lender, your credit scores and your credit history.
An estimated range of interest rates on personal loans for consumers with fair to good credit is currently between 6% and 36%. You can check on rates available in your state and apply for a personal loan at Experian CreditMatch™.
Personal loans are considered unsecured debt, which means there is no collateral, such as a home or car, to back the loan. Personal loans, like auto loans, are considered installment loans because you borrow a set amount of money and make the same monthly payment over a set period of time to pay off the debt.
Although it is important to shop around for the lowest interest rate, each time a lender pulls your credit history, it is noted on your report. These are called hard inquiries and remain on credit reports for two years. Having too many hard inquiries on your report can have a negative effect on your credit score.
Evaluating a Personal Loan
Before you take on a personal loan, it is important to determine the following information:
- Principal: the amount you borrow, which will be divided into equal monthly payments.
- Interest: you will pay a monthly interest charge.
- APR: the annual percentage rate and incorporates both your interest rate and any lender fees, which is the total cost of your loan.
- Loan Term: the length of time or number of installments to pay off the loan.
Comparing APRs is a good way to compare the affordability and value of different personal loans.
How Personal Loans May Affect Your Credit Scores
Applying for personal loans can have a slightly negative impact on your credit scores if you generate too many hard inquiries. One way to avoid multiple hard inquiries on your credit report is to conduct your loan comparison shopping during a short time period to minimize the impact.
Most credit scoring models will count several hard inquiries for the same type of credit product as one single event if they occur in a window of a few weeks. Don't start your comparison shopping, take a break and pick it up several weeks or months later.
Another option is to become prequalified for a loan offer, which is when you agree to provide credit information to a lender in order to shop for credit offers. If you decide to take advantage of one of the prequalified offers, you must then apply, which will result in a hard inquiry on your credit report.
However, some lenders may also offer you preapproval, which is initiated by the lender to determine whether you are qualified for a loan. Preapprovals are offered only as the result of soft inquiry credit checks. For more on the difference between prequalification (also known as prescreens) and preapproval, click here.
The good news is that personal loans can also help improve your credit scores if you establish a track record of making on-time payments on your personal loan. If you handle a personal loan responsibly, your credit scores can improve thanks to improved payment history and in addition to the types of credit in your credit file.
However, if you pay late or miss payments altogether, that will have an adverse effect on your credit. Late or missed payments can lower credit scores, and a lower credit score can limit your ability to access credit with favorable terms.
Read more here about where to get a personal loan.