A personal loan is the perfect solution because you will get additional flexibility compared to other predesignated options. Some lenders may ask you about things you wish to buy with borrowed money, but most will check whether you can repay everything plus interest on time.
Although they are more expensive than other secured loans, you should know they can be the perfect option in numerous situations. Still, they are more affordable than credit cards and payday loans, which is vital to remember.
How Does It Work?
You probably understand that some options you can use for specific purposes only. It means you can purchase a car, get a household through a mortgage, pay for college with a student loan, and many more.
When it comes to mortgages, your home will act as collateral. The same thing works for a car loan because you will use a vehicle to guarantee you will repay the amount you took.
However, getting a personal loan does not come with collateral, meaning it is unsecured. As a result, you will not use your belongings or assets as a form of protection. That is why lenders consider it as a loan with higher risk than others, meaning you will get a higher interest rate than you would get with secure options.
In some situations, you can choose secured option. Therefore, you can use a car, bank account, or other property as a guarantee that you will repay the debt. Still, the percentage you must pay depends on personal factors, including debt-to-income ratio, credit score, etc.
Remember that a secured personal loan is simple, and you will get a lower interest rate than an unsecured one. However, you can lose collateral if you cannot repay the monthly installments, which is a vital factor to remember.
The inability to repay an unsecured has specific consequences because it will affect your credit score, which will not allow you to get credit in the future. The company behind a credit score or FICO states that the payment history is one of the most critical factors for creating a score.
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When Should You Get a Personal Loan?
Before making up your mind, it is vital to consider whether you can choose more affordable options to borrow money. We can differentiate numerous acceptable reasons for getting a personal loan, including:
- You cannot qualify and get a low-interest credit card
- It is the least expensive borrowing option based on your preferences and requirements
- Credit limits on your credit card do not meet your needs
- You do not have proper collateral to offer
You can also consider it when you decide to borrow an amount in a well-defined and short period. They run from one to five years, meaning you will get a lump sum of money and repay everything in a few years.
That way, you can boost your credit score, especially if you repay everything on time, meaning you can get a more significant loan in the future. It is vital to remember several circumstances when getting it is essential.
1. Consolidating Debt
Having a credit card means you can quickly enter a point where you will not pay the outstanding balance, meaning you will end up with late fees and other penalties such as a two-digit interest rate. Therefore, you can get a personal loan to pay everything off and save money.
The average interest rate on a credit card in 2022 is twenty percent, while the average rate on a personal loan is approximately ten percent depending on your financial situation. As a result, you can get it to handle the balance payment faster, avoid significant expenses and reduce overall debt.
Instead, you can apply for a new credit card with a low-interest rate. At the same time, you can streamline a few payments into a single, which will assure additional convenience while paying. Of course, you can choose other debt consolidation options too.
Some balance transfers will give you a grace period of a few years, meaning you can repay everything without additional expenses. The same thing works for other emergency loans featuring significant interest rates.
Therefore, if you have a payday debt, you will carry a higher interest rate than both credit card and personal loan. At the same time, you can significantly consolidate past personal loans with higher interest if you improve your credit score and qualify for better terms. As a result, a new one can help you save money in the long run.
Before making up your mind, we recommend you determine whether a past option comes with prepayment penalties, while the new one also features origination fees. These factors may affect your chances of saving money, which is why you should ensure that taking a new debt will help you save money as time goes by.
2. Home Improvement or Large Purchase
Taking advantage of new belongings, appliances, furnaces, or other significant purchase requires additional money you cannot save as fast as you think. Instead of using a credit card to take the money, you can choose a personal loan.
Another option with low expenses is tapping home equity through HELOC or loan, which will provide you peace of mind. The main downside of both options is using your home as collateral, which is vital to remember. At the same time, tapping home equity is not tax-deductible unless you use it for home improvements.
3. Major Life Event
Similarly, like any other significant expense, handling an expensive event such as bat mitzvah, wedding, anniversary party, or anything else requires plenty of money, which is why you should avoid using a credit card and entering the debt.
According to statistics, one in five US couples will use investments or loans to pay for the wedding. Since these events are critical and happen once in a lifetime, you should consider the best financing option because some require a few years to repay.
It is useless and stupid to pay a loan for the next two years just for a single vacation. That is why we do not recommend you to borrow money to go on vacation, unless you decide to move from one place to another. Still, taking a personal loan and handling everything on time will boost your credit score and help you get a mortgage in the future.
4. Boost Your Credit Score
Taking advantage of a personal loan and handling it on time will help you boost your credit score. For instance, managing a small debt will increase your situation if you have a history of missed payments and defaults. Therefore, when lenders take out your credit report, every missed payment will be a part of it.
Borrowing money in hope of improving your score is a dangerous decision. But you can reap the benefits of paying all bills on time, while reducing the credit utilization ratio and debt-to-income. However, when you have a few different loan options, you can show them you became more responsible than before, meaning you can get into major debt afterward.
Requirements to Remember Before Applying
It is important to remember that personal loan requirements vary by lender, but all of them will consider a few things, including income, credit score, and job stability. Therefore, before you start shopping for it, you can familiarize yourself with the standard requirements you must check out and the documents you should prepare.
- Credit History and Score – One of the most critical factors is a credit score, mainly when the lender determines whether you can handle the monthly installments. Scores range between 300 and 850 and depend on various factors, including the amount of outstanding debt, payment, and credit history. Numerous lending institutions will require at least 600 points to qualify, but the higher your score is, the better rates and terms you will get.
- Income – You should remember that lenders will create income requirements to ensure you can quickly repay the new loan. The minimum income requirement depends on the lending institution you choose. You should bring evidence of income in the form of monthly bank statements, tax returns, signed letters from employers, pay stubs, and many more. You will need bank deposit and tax returns if you are self-employed.
- Debt-to-Income Ratio – You should know that DTI comes in the form of a percentage, meaning it represents a portion of the monthly income you pay for bills and other debts. Lenders will use it to predict whether you can make on-time payments when adding the new debt into your situation. That is why you should have a max of thirty-six percent of DTI, while reaching the lower percentage is way better and will offer you peace of mind.
- Collateral – Finally, when choosing a personal loan, you may decide to get a secured option meaning you should use your asset or valuable belonging as collateral. Regarding vehicles and homes, the collateral depends on the loan’s purpose. However, with personal loans, you can use other assets, including investment or cash accounts, real estate, or collectibles such as precious metals.