Personal loans are unsecured debt because you are not required to collateralize the loan with your home, car, or other tangible assets. Banks, credit unions, and other lenders primarily use your credit score to determine whether or not to give you this type of loan and its interest rate. Unsecured loans generally have higher interest rates than secured loans, so you should only consider a personal loan if you’re able to pay it off quickly.
Unlike credit cards and lines of credit, personal loans are not revolving loans. Personal loans are installment loans that are paid over a defined period of time with a fixed interest rate. Payments are most often made on a monthly basis and consist of both principal amount and interest payments. The loan term can range from one to five years and amounts vary between $1,000 and $100,000.
Personal loan lenders can generally tailor loans for any credit score. You do not need to have perfect or even average credit to take out a loan. Though having great credit, long-term and stable employment and financial history, a reasonable debt to income ratio, and minimal credit inquiries on your account will almost guarantee you instant loan approval, those with less-than-perfect or even low credit scores can work with specialized lenders to meet their financial goals. These specialized loans may carry additional fees and higher Annual Percentage Rates (APR), but it is also possible that the loan will improve your credit score over time and allow you to refinance your loan in the future with more competitive rates. This is because installment loans carry more weight than revolving credit accounts when your credit score is calculated. If you make your monthly payment on time each month and never miss a payment, you will see your credit score slowly start to improve over time.
There are many types of conventional, alternative, and emerging lending options available. These include large financial institutions, smaller regional banks, Federal and non-Federal credit unions, online banks, Peer to Peer (P2P) lending platforms, payday lenders, and private loans from close relatives and friends. You should immediately exclude payday lenders from your list of options. Paydays lenders are known to charge exorbitant fees and interest and, in the event of nonpayment, stop at nothing to recover their funds. Many states have implemented caps and other limits on payday lender fees, interest rates, and collection techniques given how unscrupulous some of these businesses have become. Be very cautious when considering a payday loan!
Large financial institutions are normally the most difficult lenders to receive loan approval from if you have an average or low credit score. Though you may be able to leverage an existing long-term relationship with your bank, especially in an emergency, there are normally very strict guidelines that must be implicitly met prior to a loan being issued. Though these loans will probably carry the lowest interest rates and have the best terms, they are normally reserved for those with above average, good, or excellent credit scores.
Smaller regional banks have the flexibility to make loans under less than ideal borrower risk conditions. These banks are usually much smaller and your relationship with them will be more personal. Given that they’re trying to grow their business through new business, fees, and interest payments, the metrics used to gauge loan eligibility are often less strict. That's not to say that every regional bank will work this way. But, if you have average or below average credit, there is a much better chance that a regional bank will risk lending you the money over a larger national financial institution with strict lending policies.
Federal and non-Federal credit unions fall under the same category as regional banks. Credit unions are not for profit organizations that use account holder deposits to loan money to its members at low interest rates. They are essentially cooperative banks where everyone is invested in each other’s success and members are expected to meet their obligations for the credit union’s better good. As such, establishing and maintaining a good working relationship with a credit union can lead to many exciting lending opportunities, especially if you wish to form and finance a business. There are also federal credit unions that cater specifically to military, government, and government contractor personnel. Though they work the same way as a regular credit union, their membership is limited to government employees.
Peer to Peer (P2P) lending is an emerging loan option. P2P lenders use an online platform to match people with money to lend with those who need money. The fees and interest rates associated with these loans are much higher. But, recent studies show that borrowers are defaulting less on P2P loans and in many instances paying them off early. This is likely because borrowers are now seeing the funds they received as “real money from real people” as opposed to “bank money.” This type of personal connection creates more of a sense of responsibility to pay than conventional bank lending does. Given the rapid growth of the P2P market, it’s certain that you’ll see more options become available over time with lower interest rates catering to a wider range of credit scores.
An alternative lending option may be closer to home than you think. There is no shame in asking a close relative or friend for a loan with a reasonable interest rate. You’d be surprised how many people actually have surplus cash on-hand and are willing to lend it to you for a small return. Of course, this would be mean that you are risking a personal relationship to address your financial situation, and you may be questioned why you need the money. But, if for some reason you can’t make a payment in the future, it is much easier to explain the situation to a loved one or close friend than a bank. It is good practice to document any loan that you take out with a friend or relative. Just like a bank, there is collective security for the lender and borrower if you have signed for the funds and there are agreed upon repayment terms. Though it is advised that you use an attorney to draw up the loan documents, you don’t necessarily need to if time and cost are a concern. There are many resources and templates available online for this very purpose.
Nearly every type of loan requires that you provide a certain amount of personal and professional information. At a minimum, you will be expected to provide your full name, residential address, employer and income details, your Social Security number, and likely your monthly rent or mortgage payment amount. This information is used to obtain your FICO or a specific credit bureau credit score, as well as determine your debt to income ratio. As of writing, there are no reputable lenders in the United States that won’t require this information, so you should have it prepared prior to checking for various loan offers.
If you previously took out a personal, debt consolidation, or another type of loan and you’re looking to refinance it, it’s likely that there’s competitive personal loan options available to you if you’ve been diligent in repaying your current loan. Many lending companies specialize in refinancing existing debt, especially for people who have shown discipline in addressing their debt. To refinance an existing loan, start with your bank or a local credit union. Take the time to walk them through why you took out the original personal loan, how it has positively affected your debt to income ratio and lowered your overall indebtedness, and how your credit score has improved. Banks and credit unions appreciate consistency; so, even if you still have a lower credit score, they will likely still take the chance on refinancing your debt if you have shown you always make your payments on time and never miss a payment.
Tip 1: Managing a personal loan and your debt as a whole is just as much about managing yourself as it is about managing the money itself. It is about saying "no" to yourself and your family when a potential expenditure is truly wasteful. Whether it be ordering food instead of cooking twice a week, buying toys or other items that are used once and then never looked at again, or taking a trip that you just can’t afford, you need to look at your overall finances and make better decisions. You’re not alone; we’re all guilty of spending money we don't or didn’t have at times. But, as a simple rule: Every time you’re about to order food or make a purchase beyond your normal living expenses, think about how that amount could be better used by paying down your debt. If you keep track of these decisions for a month and calculate their total value, you will be very surprised by how much you could have saved or paid down your debt that month. Then think about how that would compound in value from year to year. It’s certain that the number will be truly amazing and inspire you to save more in the future!