Personal loans are the fastest-growing type of consumer debt in America, according to Experian. In the last quarter of 2018, Americans held $291 billion in personal loan debt. This category was growing significantly faster than credit card, mortgage, auto, and student loan debt.
There’s good reason for the popularity of this type of loan. When you take out a personal loan, you’re borrowing money from a bank, credit union, or another type of lender. Very often, these loans are unsecured, meaning you don’t have to put up anything of value that can be collected if you default on the loan.
You can also use the money for lots of different reasons. While a mortgage or auto loan can only be used to purchase a home or car, respectively, a personal loan can be used to pay off bills, finance large purchases, cover medical expenses, and just about anything else. Here’s a closer look at personal loans and when it might be a good time to consider one.
When is a personal loan a good option?
There are lots of reasons a personal loan may be worth considering. Interest rates or APRs (annual percentage rates) for personal loans are often much lower than what you get with credit cards. They’re also given for a specific period of time (or term), typically with a monthly payment that stays the same throughout the life of the loan. This gives you a predictable payment schedule that you can make sure works realistically with your budget.
One thing to be mindful of with personal loans is that while they can be an effective tool for making large purchases and consolidating debt, staying within your financial means should be a big consideration.
You’ll have a monthly bill that needs to be paid for a number of years. If you won’t be able to reliably make those payments, you could be sent to collections, and your credit score could take a hit. The negative impact of missed payments or defaulting on a loan can follow you for years, making it more difficult to borrow in the future and disqualifying you from low interest rates.
What is a good reason to get a personal loan?
Though personal loans can help cover many different costs, it’s important to use them wisely. Here’s a look at some situations where taking out a personal loan may be a good idea.
A personal loan can be a smart way to pay off high-interest debt or bring several bills together into a single, easy-to-manage monthly payment that won’t last forever. You can use the money to pay off all kinds of bills, including medical expenses, other loans with higher APRs, credit cards, and more. The flexibility of a personal loan makes it applicable to just about any debt situation.
Emergency home repair
You never know when the furnace or water heater is going to break. Or when you’ll need to replace your roof or driveway. These are large expenses that can come out of nowhere, and you’ll need fast cash to get these repairs done. A home equity loan may be an option to explore, but a personal loan may be a better choice, especially if you don’t have much equity yet or only need to borrow a small amount.
Unexpected medical bills
Even with insurance, the cost of medical and dental procedures can run thousands of dollars that often have to be paid in advance. Emergency expenses, such as ambulance or transport, and continuing care after discharge can all result in ongoing medical bills that you need to find some way to pay. Taking out a personal loan can corral them into one payment and make paying them down more manageable.
Moving has all kinds of expenses associated with it, whether you’re going across town or across the country. Packing materials, movers, transportation, rentals, deposits, storage, insurance, new furniture, and cleaning are just a few of the things you’ll likely be spending some money on. Though taking on additional debt may not be the best idea when you’re in this transitional period, a personal loan can get you the cash you need to make your move. Just remember to keep your financial big picture in mind.
Paying down credit cards
Using a personal loan to pay off high-interest credit card debt allows you to not only save money on the interest, but also gives you a specific amount of money to add to your monthly budget and an end date for paying off the debt. If you were to pay on those cards using the minimum payment schedule or even making slightly larger payments monthly, it could take many, many more years to get rid of debt that you could predictably pay down with a personal loan.
Building your credit
Getting a personal loan and paying on it every month can be a good strategy for building or rebuilding credit. You may only be able to borrow a small amount, but in making timely payments, you’re increasing your credit scores by showing that you can be financially responsible. Additionally, this can diversify the mix of credit in your history, which is also a positive influence on your scores.
Just like with humans, medical bills for fur babies can be very expensive. Veterinary medicine is becoming so advanced that cancer treatments, autoimmune therapies, and surgeries are being chosen more often by pet owners. Personal loans are making it easier to pay for life-saving treatments for pets, rather than sending our beloved friends over the Rainbow Bridge.
End-of-life expenses can be great and come unexpectedly, especially if there’s no life insurance set aside for a funeral. Even if there are death benefits that can be tapped, they may not be enough to cover the funeral home, casket, burial, memorial services, and other expenses. In this situation, you could take out a personal loan to pay for final expenses upfront and finance them out over a more affordable timeframe.
How to qualify for a personal loan
Every lender has different criteria for personal loan qualifications. Traditional banks, credit unions, and online lenders are all good places to look for personal loan options. Credit scores and debt-to-income (DTI) ratio are probably the two most important factors in their decision for approval.
Before you apply for a loan, it’s important to know what your reports from each of the three credit bureaus (Experian, Equifax, and TransUnion) say, what your credit scores are, and if your credit history is being reported accurately. Lenders will be looking closely at these reports, which will help determine not only if you’re approved for a loan, but also whether you’ll get a high or low interest rate. Experian reports that interest rates for fair-to-good credit scores can range from as low as 6% to as much as 36%.
Most lenders look for at least a fair credit score, generally around 580 to 669, to approve a personal loan. Though higher scores are better for your loan, a lower score doesn’t necessarily disqualify you from getting approved.
When lenders review your DTI, they’re looking at how much money you make before taxes and other deductions versus how much money you owe every month in debt. This will give them an idea of what you can afford to pay on your loan monthly. Generally, lenders like to see a DTI of less than 43% — and the lower your percentage, the better.
Is a personal loan the right option for you?
Now that you know a little more about personal loans, it’s up to you to decide if applying for one is right for your financial situation. Remember to carefully consider whether or not you can comfortably add another monthly payment to your budget and, if you do, how that will impact you in both positive and negative ways. You may end up finding that a personal loan is just what you’ve been looking for to improve your financial outlook.