Most consumers’ experience with credit comes in the form of a mortgage, auto loan, credit card or, for the ambitious entrepreneur, a business loan. As helpful as all those forms of credit can be, they all have specific purposes and restrictions that hinder their flexibility. What if you just need some extra cash for personal reasons?
That’s where a personal loan comes in. Let’s say you’re looking to consolidate a bundle of credit card debt or deal with medical bills from an uninsured operation. Maybe you just want to replace, repair or refurbish some aspect of your home – or even expand. This versatile debt vehicle can be used for all those reasons and more.
But as useful as a personal loan can be, it’s also a market that attracts predatory lending. If you don’t take the borrowing process seriously, you could end up working with a creditor whose only goal is to take you for everything you’re worth. In other words, you need to do some research before you decide who to borrow from.
Thankfully, we went ahead and gathered all the basic information you need to get started. Here’s how you can best compare personal loans to find the right fit for you.
What is a personal loan
Personal loans are taken out for a variety of reasons, including debt consolidation, medical expenses, vacations, weddings and more. Personal loans are most often unsecured, which means there is no asset or collateral tied to the loan.
A mortgage or auto loan is a secured loan, because if the borrower defaults or the debt goes to collections, the bank can repossess the asset tied to the loan – a house or a car – and resell it.
The collateral protects the lender, and in turn, they usually offer a better loan to the borrower because they have recourse in case something goes wrong.
A popular type of secured personal loan is a title loan, where the borrower trades in the title of their car in exchange for the loan. If they default or miss payments, the lender can then seize ownership of their vehicle.
But since most personal loans are unsecured, there’s nothing for the lender to take if you stop making payments, so the risk is higher for the lender.
Repayment terms for personal loans have an average range of 12 to 60 months, with the most common term being three years. The repayment term will help determine your monthly payment and how much you pay in interest, since the longer your loan is, the more interest you’ll owe.
When you get offers for personal loans, compare their repayment terms – especially the length and size of the monthly payments. Calculate the total interest you’ll pay overall to see which is the better deal, but never take on a monthly payment you can’t afford.
Personal finance expert and founder of WellKeptWallet Deacon Hayes said people should seriously examine any fees being charged on a personal loan.
“When looking at getting a personal loan, not all loans are made equal,” he said. “Some may have origination fees which mean that you will pay a fee to just get the loan.”
Banks typically charge between .5 and 2% for an origination fee, which you can pay when you take out the loan or finance it as part of the original loan. For example, the origination fee for a loan of $30,000 will be between $150 and $600. Not every lender charges an origination fee, so be sure to ask about that before you sign up.
“Other loans might have a prepayment penalty which is not good if you are trying to pay off a loan quickly,” Hayes said. “This is where you get charged a fee for paying the loan off before the term of the loan is up.”
Prepayment fees are popular with personal loans, and there are multiple ways that lenders calculate prepayment penalties, including a percentage of the total interest you’ll save by paying off your loan early. Always try to find a personal loan with no prepayment penalty, which punishes those who are the most responsible with their money.
Every lender has their own guidelines on how much credit they’ll provide to a prospective borrower, which usually depends on your credit card, income, employment history and more. Some banks are only comfortable lending $30,000 while others give out a six-figure loan with relatively little fuss.
No matter what you need the loan for, calculate exactly how much money you need and filter out lenders who can’t give you that whole amount. If the bank offers you more money than you need, politely decline. The more you borrow, the more interest you’ll have to pay and the more dependent you could become on debt.
The interest rate is one of the key factors to examine when comparing multiple personal loan offers, since it determines how much interest you’ll pay over the life of the loan as well as the size of your monthly payments.
The higher your credit score, the lower interest rate you’ll qualify for. Unfortunately, those with low credit scores will have to pay higher interest rates than those with good or excellent credit, such as 35% APR compared to 6%.
According to NerdWallet, average APR for those with credit scores between 720-850 is 10.94% while those with a score of 580-629 will get an APR of 28.64%.
Most personal loans have a fixed interest rate, which means that the interest rate will stay the same the whole time. Only a few come with a variable rate, which is when the interest rate fluctuates between a certain range depending on market conditions.
Where to start
In the era of online banking and lending, finding a loan is easy – but finding the right one with no fees, low interest rates and good customer service? That’s much, much harder. Here’s a step-by-step guide on where to look first for your personal loan.
Even though they’re not as well-known as major banks, credit unions are famous for offering low interest rates. Because credit unions are not-for-profits and therefore not beholden to strictly for-profit goals, they can afford to beat banks with better interest rates and fees. If you already have an account at a credit union, contact them about your options for a pre-approved loan.
You might be surprised at the terms they can offer you, even if you’re not currently a member. A customer service report found that credit unions also have happier customers than traditional banks. Because most credit unions are small and local, you’ll probably have to call or visit in person to talk about your options for a personal loan and what you might qualify for.
If you already have a bank account with a national or regional bank, reach out to see what kind of personal loan you qualify for. Depending on the branch and your history with them, they might have competitive interest rates and no extra origination or prepayment fees. Try to research a few banks in the area to see what they offer and where you can find the best deal.
Peer-to-peer sites like Lending Club and Upstart are popular with people who need a personal loan and don’t want to get one with a bank or credit union. Like their name implies, peer-to-peer sites use real people as the investors, so when you borrow money, you’re getting it from individuals who you then repay with interest.
Interest rates depend on your credit score, but some sites, like Upstart, also take into account your education level and professional experience.
Even though they sound unconventional, peer-to-peer sites are still mostly available for those with good credit and often require a credit score of 620 or higher. If you have poor or no credit, you might not be able to qualify for a personal loan with these companies. Check multiple sites to see what you’re pre-approved for, in order to determine if it’s better than going the traditional personal loan route.
Family and friends
If you’d like to make the personal loan even more personal, you could ask a friend or family member to lend you the money. This is a riskier option, and should only be considered if you’re entirely confident in your ability to pay back the loan – or comfortable with damaging your relationship in the event of delinquency. A family member or friend will probably be willing to offer better rates than any professional lender, and be more understanding in the event of a setback.
If you’d like to explore this route in the most responsible way possible, meet with a lawyer to draw up a contract that both parties agree on. That way you’ll both be clear on the terms, and there won’t be any room for doubt or misunderstanding. Remember that defaulting on a loan from a family member or friend will have emotional consequences as well as financial, so tread lightly.
The bottom line
Taking out a personal loan is like buying a car. You wouldn’t just take the first sedan you see. You’d want to read reviews, take it for a test drive and wait for a few days.
Always consider every offer you get for a personal loan and compare them objectively. You want the best rate, lowest fees and friendliest customer service. Remember, this loan will impact your finances for a long time so don’t rush into it.