Your Personal Guide to Personal Loans
A personal loan is:
- For a relatively small amount (often $2,000-$3,000).
- Repaid relatively quickly—most commonly, two years.
- Typically “unsecured,” meaning you do not have to put up any collateral that you would risk losing if you failed to pay.
When should you get a personal loan?
Personal loans are often the best option for people who are in a crisis situation in which they need Read More...
Your Personal Guide to Personal Loans
(Continued) the money quickly, and can’t get it from savings, family, or friends. In this situation, a personal loan is a much less expensive option than a credit card cash advance.
A personal loan is also preferable to having your car repossessed or your house foreclosed for a missed payment, leaving a friend or family member in jail for lack of bail, or facing whatever other crisis you may be confronted with.
For non-crisis situations, personal loans are rarely the best option—though they’re usually still better than credit cards
. You should generally only turn to personal loans if you really need the money and cannot get it from your savings, family, 401(K), home loan, or another source that charges less interest—in short, if your only alternative is a credit card.
Personal Loan or Home Loan?
Personal loans are far more expensive than home loans
. But there’s one advantage of personal loans that’s not often discussed: they’re ultimately less risky. Unlike home loans or car loans
, personal loans are not usually secured—meaning there’s usually no collateral for the lender to seize if you default.
If you’re in a financial crisis now, you have to keep in mind the possibility that your troubles may be compounded by another financial crisis in the future. In short, if your finances get worse and you can’t pay back your personal loan, at least no one will auction off your house.
How Are Personal Loans Better than Credit Cards?
If you walk into a bank and ask for a personal loan, they may push you towards a credit card instead. But personal loans are probably better for you, precisely because on average you’ll end up paying less to the bank. Do your research and stand your ground if pressured to apply for a credit card instead of a personal loan. After all, it’s your money.
Similarities between Personal Loans and Credit Cards:
- Interest rates tend to run around 10% to 20%.
- Typically unsecured—i.e., you don’t have to put up collateral.
- The amounts of money involved are typically a few thousand dollars or less (and sometimes even less than $500).
Advantages of Personal Loans over Credit Cards:
Personal loans have a fixed repayment period, with a pay-off date you can look forward to. Of course, you could force yourself to pay off your credit cards within a fixed period. But with a loan, the repayment period is based on a contract, rather than will power, so payoff success rates are much, much higher.
Credit cards are a revolving line of credit. Personal loans are installment loans, like mortgages. When you make a payment you do not suddenly free up an equivalent amount of credit you can charge against. This is another reason why, practically speaking, the average person is likely to end up getting out of debt faster with a loan.
Personal loans have a set interest rate that cannot normally be raised at the whim of the lender. Credit issuers often raise the interest rates of customers who approach their credit limits—another reason the banks usually prefer giving out credit.
Personal Loans Comparison Shopping Checklist
If you belong to a credit union or can join one, check there first. Rates tend to be lower and terms more generous at credit unions than at banks. If you cannot join a credit union, you should at least investigate bank rates and terms online before applying. Use the checklist below to make sure you’re getting a good deal.
- The interest rate is fixed___ or variable___. If variable, the rate cap is ____ or there is no rate cape____.
Tip: there should be a trade-off here: a variable rate should be lower to start out with, since rates are expected to rise in the long term rather than fall. Yet any discount in that initial low rate could be wiped out by higher rates in the future. You can soften your risk with a rate cap, but you’ll also be softening your discount.
- Annual fee: $____ or no annual fee ____.
- Monthly fee___.
Tip: A low monthly fee does not necessarily equal a cheaper loan. A higher monthly fee may let you pay the loan off faster, or simply reflect a lack of add-on fees.
- Other payments and fees: $____ or none ___.
Tip: You should keep an especially sharp eye out for credit insurance, buying clubs, and add-ons that may very well end up being worthless. Lenders often try to slip these into the agreement wrapped in confusing language, or try to imply that everyone who gets a loan pays these fees.
- Total cost of the loan (principal plus interest and any and all fees whatsoever): ______.
Tip: This is ultimately the most important number. You should explicitly ask the lender what the total costs will be before signing anything. Make sure you can find the lender’s promises in your loan contract. All lenders know this number and can even do quick estimates for various contingencies (such as you pre-paying part of the loan later on). If a lender refuses to tell you in one simple number what the total cost of the loan will be, run, don’t walk, the other way.
How to get a personal loan if you have a bad credit history
If you have a bad credit history
, you will have a hard time getting a personal loan at a competitive interest rate. Of course, having had trouble with credit in the past may be a particularly good reason to avoid personal loans in the first place. But if you have no other choice, and are confident you can make the payments, here are some tips.
- Try a credit union. Not only are they usually less expensive, they are often more forgiving.
- Go to your own bank. If you can’t go to a credit union, at least try getting the loan from your own bank. If you have a good record with them, they may be more obliging. Of course, few banks actually advertise personal loans, and some really do not offer them. But it can’t hurt to ask.
- Offer some collateral. While personal loans are generally unsecured, a good loan officer may be able to help you borrow against an insurance policy, property, or other asset. Of course, collateral makes it all the more urgent you pay this loan.
- Get a co-signer. This is an even riskier option than offering collateral. You stand to lose not just an asset but your relationship with a friend or loved one if you default. But if your problem with credit really was just a fluke, and your prospects for repaying the loan are excellent, it might be worth the risk. Just don’t take it personally if your friends or relatives reject your request—after all, they have a lot more to lose than the banks.
- Don't apply for multiple loans all at once. You may look desperate and lose your chance of getting any of them. Of course, getting rejected for a loan will also hurt your chances of getting approved for a subsequent one, since it will raise a red flag. The only solution is to do your research, have some frank conversations with the loan officers, and then apply for the loan you have the best chance of getting.
In the end, the best advice about personals might be not to get one unless you absolutely have no other choice except credit cards. If a personal loan really is your best option, make sure to follow all the tips above when researching where to go.
Return to Top