Lenders ask a lot of questions when you apply for a loan. Among the most personal ones you may have to field before you borrow is, “Why do you need this money?” Sometimes the answer is clear. You take out a car loan to finance a new ride and a mortgage to buy a new home. But what if you’ve been working for a year straight and crave a Hawaiian vacation? What if you need to take time off from work to care for your aging dad? What if you have a brilliant product idea and want to start your own business? When your reasons for borrowing are more personal, a personal loan might be the answer you’re looking for.
Is a Personal Loan Right for You?
You’ve probably already guessed the answer to that question. It depends. If you have other borrowing options, for example, a home equity loan or a home equity line of credit—or a rich uncle, for that matter—it’s important to compare them side by side to see which choice makes the most financial and practical sense.
Generally speaking, home equity loans come with lower interest rates. That’s because they’re “secured” or attached to a financial asset—your home. From a practical standpoint, when you take out a home loan, your lender essentially “owns” a portion of your home. But if you don’t own a home or have substantial equity in the one you do own, you won’t be able to get a home equity loan. That’s a good reason to consider a personal loan.
What are The Advantages of a Personal Loan?
We’ve already discussed how personal loans offer borrowers more flexibility. You can spend the money you borrow on whatever you choose, from paying off high-interest credit cards to hosting a one-of-a-kind wedding for your daughter.
Applying for a personal loan is a simple process. You may be approved in just minutes if you apply online. Once you’re approved, you’ll get your loan proceeds quickly—normally within a few days. That’s a critical advantage if you need cash to pay for an emergency, such as unexpected medical expenses.
Two Types of Personal Loans
While most personal loans are unsecured, it is possible to use one or more of your financial assets as collateral to take out a secured loan. Secured personal loans are typically offered at lower interest rates than unsecured loans. You may be able to use cash savings, investments, or a life insurance policy as secured loan collateral. But secured personal loans come with some risks. For example, let’s say you use your stock portfolio to secure your loan. Your stocks are earning you dividends and are gaining value at a higher rate than the rate you may be able to borrow under. It makes sense to stay invested rather than to draw cash out of a high-performing portfolio. Then suddenly, the market goes all bearish on you. You’re no longer getting the same return on your investment and your portfolio loses value, perhaps to the point where it dips below your personal loan balance. But you’re still responsible for making your payments and if you miss one, your lender can seize the asset you used to secure your loan. And you’re still responsible for the full amount you borrowed. That’s not a great position to be in.
Getting Approved for a Personal Loan
Lenders look carefully at your credit history before issuing you a personal loan. Most set a minimum credit score you must meet before they’ll let you borrow. Do you know what your score is? Many people don’t—as many as 35% of Americans, in fact. Having a higher credit score is likely to give you more options when you apply for a personal loan and earn you a lower interest rate, too. Before you apply, be sure to know where you stand credit-wise. You can download a free copy of your credit report from each of the three major credit reporting bureaus once per year. That’s important to do annually regardless of whether you’re applying for a loan. Often, the details revealed on a credit report are the first clue consumers have that their identity has been stolen. Identity theft has been growing more common for years.
Beyond just checking your score, you should comb through your credit report for any mistakes that may be dragging your score down. These include erroneous late payment notes, credit accounts you don’t recognize—one clear harbinger that you’re a victim of identity theft—and accounts you may have closed. Disputing the details on your credit report is a slow and sometimes frustrating process. Many consumers enlist the help of a professional credit repair company. The best credit repair companies employ both experts in credit reporting and artificial intelligence to speed the process of improving your credit.
Do-it-Yourself Tips for Boosting Your Credit
If your credit score is sub-par, the best thing you can do to raise it is to bring all of your credit accounts up to date. Late payments and past-due accounts have the highest impact on your credit score and you can see a pretty quick boost if you attend to paying all of your outstanding credit card bills.
Credit bureaus also look at your credit utilization ratio when assigning you a score. The lower the percentage of your available credit you’re using the better. If you’re using more than 30% of the credit companies are offering you, you may have difficulty getting a personal loan. It may seem counterintuitive, but one way you can improve your credit utilization ratio is to request more credit. Choose a credit card that has a zero or low balance to increase your chances of being approved for a higher credit limit. Just don’t use the card. That will cancel out the positive effect on your credit score of having more available credit.
Looking Beyond Your Score
There’s one factor lenders consider before offering you a loan that you won’t find on your credit report: your debt-to-income (DTI) ratio. That’s because they want to be sure you have enough money coming in to cover your monthly loan payments. You can figure your DTI ratio easily using an online calculator. All you need to know is your total outstanding debt—included in your credit report—and your income. If your DTI is below 36%, you’re within the range lenders want to see. If it’s higher, you may want to try to reduce your debt before applying for a personal loan. Even having a few more mortgage payments under your belt can make a difference in the interest rate you’ll be offered. And a low interest rate makes any loan you take out more affordable.
