Are you looking for a way to cover a big expense in your life? If so, you may have wondered, what are personal loans…and can they help you meet the financial needs you’re facing? These are great questions because when it comes to personal loans, there are important things to consider before you sign on the dotted line.
What Are Personal Loans?
Let’s start with the basics. What are personal loans anyway? A personal loan is a sum of money borrowed from a financial institution to pay for pretty much any personal need (more on that later). “It's a very open-ended kind of loan; you could use it for a wide variety of purposes. The lender may ask, but sometimes they honestly don't even need to know,” says Matt Schulz, Chief Credit Analyst at LendingTree, and author of “Ask Questions, Save Money, Make More: How To Take Control Of Your Financial Life.” Borrowers can apply for a personal loan at their local credit union.
Is A Personal Loan Right For You?
Should you get a personal loan? It all depends on your needs. By far, the most common reasons why people take out personal loans are debt consolidation and credit card refinancing, explains Schulz. “Used wisely for those purposes, the right personal loan can save you significant money, slash your payoff time and even reduce the amount of bills you have to pay each month. That’s a big deal, especially considering how tight people’s budgets are and how long people’s to-do lists can be.”
Also on the list of common uses for personal loans are things like home improvements, car repairs, medical expenses — and even weddings. Also, a LendingTree report from June 2023 showed that some people even get personal loans just to pay everyday bills. “That’s troubling, but in a time of stubborn inflation and record debt, we shouldn’t be too surprised,” says Schulz.
Ideally though, no one should take out a personal loan unless they’re truly in need — and something like a wedding falls distinctly into the “wants” category of our budget. Keeping our debt and its associated costs down should be our top financial concern at all times.
What To Look For In A Loan
Once you’ve decided it’s time to apply for a personal loan, your first move should be to shop around for the best rate. That starts with taking a look at your credit score. (You can get a copy for free!) How high or low your credit score is will make a big difference in the terms of your annual percentage rate (also known as your APR), which is the cost of borrowing funds from your lender. While that’s true for any type of loan you apply for, according to Schulz, it can be particularly extreme with personal loans. “The lower your score, the higher your APR,” advises Schulz. “For some, the rate can even go into the triple digits, which is crazy.”
One of the advantages with personal loans, unlike credit cards for example, is that they have fixed rates — a definite plus given the volatility of interest rates in recent years. “There’s a certainty with fixed rates,” says Ted Rossman, a Senior Industry Analyst for Bankrate. “That’s another contrast with something like a home equity line of credit (HELOC), where with a lot of people, in the past two years, their HELOC rate has shot up, potentially five percentage points or more.”
In addition to rates and fees, lenders will also have differences in the term of the loan they offer, the amount of time it can take to receive the funds, and the amount you can borrow. For example, some lenders will offer only up to $20,000, and others could offer up to $100,000. It all depends on the financial institution, as well as other factors like your credit score.
Start by visiting your credit union’s website to see what types of loans they offer, then do some comparison shopping online. “Shopping around is crucial,” stresses Schulz. “There can be a big difference from lender to lender, but you won’t know unless you compare.”
What To Know As You Apply
Once you’ve landed on the personal loan you think is a good fit, it’s time to actually apply. Experts say that most of the time, the process is quick and easy. “One of the reasons people are drawn to personal loans is the fact that you might submit an application online today, and you might have the funds in your account by tomorrow,” says Rossman. “That contrasts with something like a home equity loan or line of credit, where there could be lots and lots of paperwork, and maybe weeks before you see the money.”
You will also want to consider the length — or term — of your loan. Typically, the term of the average personal loan will range from two to seven years. Lenders may offer a longer-term loan if you’re borrowing a significant amount of money. Before you accept a loan, you’ll want to make sure you’re weighing the term of the loan, as it will have a direct impact on your cost per-month, as well as your long-term cost. Ideally, experts say you want to strike a balance between payments that fit within your monthly budget (since you’ll be paying the loan off in fixed monthly payments) and overall interest costs you’ll have over the life of the loan.
Once you apply, you may be offered more money than you initially thought you needed. A word to the wise: Don’t take all of it — you should always try to borrow as little as possible. “If you have decent credit, you may find that lenders are willing to give you more than you need,” says Schulz. “While it may be flattering to be offered all that money, the truth is that you shouldn’t borrow more than what you have use for. That can be a recipe for trouble.”
The Bottom Line
While we should all be mindful of keeping our debt and its associated costs down, personal loans can be an important tool when it comes to paying for life’s essentials, or recovering from credit card debt. The main rule of thumb when it comes to personal loans is making sure the amount you’re borrowing fits within your overall financial plan, and that you’re being responsible when it comes to what you use the money for.
