Personal Loans

A personal loan is a catch-all term for any non-specialized loan. You've probably heard of mortgages, car loans, and the like. These loans have specific functions (buying a home and a car, respectively). A personal loan, on the other hand, is a generic loan where you get money from a lender, usually a bank, and pay it back piece-meal. Personal loans can be used for anything (nondiscriminatory) and are usually only available to individuals with strong credit, since they're so open-ended.

Since personal loans are applicable to an almost limitless variety of circumstances, the interest rates on personal loans vary greatly, with annual percentage rates (APRs) from 6% to 36%. Interest rates for personal loans are usually fixed, which means that the rate stays the same regardless of market fluctuations. Generally, rates for personal loans tend to be higher than loans with a specific function, such as student loans, because there is a higher risk that the money will be spent irresponsibly or will not be recuperated by the lender. For personal loans, as with many kinds of loans, APRs are higher if you have a low credit scoreSecured personal loans

(loans with collateral) have lower APRs than unsecured personal loans (loans without collateral) since the lender can recover some of their losses if the loan is in default.

Lenders place a lot of emphasis on credit scores for personal loans. Unlike a small business loan, which might be given to someone based on the strength of a business plan despite bad credit, a personal loan hinges on credit for trust. Most personal loans ask for minimum FICO credit scores between 640 and 750. There are some loans which will are available with scores as low as 600, but those tend to have untenably high rates. Secured loans have lower credit minimums than unsecured loans due to the collateral securing the loan. In addition to credit requirements, most personal loans require applicants to have a steady employment history and a debt to income ratio (the percentage of your monthly income which goes to minimum debt payments) of 45% or less.

Having a bad credit score can be a real barrier to good financing, and, frustratingly, it’s difficult to improve your credit if you can’t get loans to pay down. While almost all legitimate personal loans have some credit requirements (be wary of loans without any credit standards), there are several options for those without great credit. If you have assets available to you, such as a home or a car, you can use these assets as collateral which can lower the credit minimums for personal loans by securing them. The closer the value of the collateral is to the value of the loan the more it lowers the credit minimum. Another option is to have a loved one with a higher credit score act as a co-signer. The lender will then factor in both your credit score and the credit score of the co-signer. If you do get a co-signer, be aware that their credit score is now linked with this loan, so if you are late for a payment you will negatively affect not only your credit score but theirs, too. There are several options out there for personal loans that only require a minimum credit score of around 580 or 600. These loans tend to have very high APRs (25%-35% compared to 6%-15% for personal loans with higher credit standards). It’s better to get a lower cost loan if it is a possibility, but if there are no good options you can get a small loan and use it strategically to help rebuild your credit. For more information on rebuilding your credit, you can check out our guide here.

A personal loan is considered secured if it is backed by collateral and unsecured if it is not. Collateral is an asset that the lender can take if you can’t pay back your loan. Having collateral lowers the risk that the lender will lose money on the loan. To incentivize secured loans, lenders offer better rates and lower credit minimums. The one downside of secured loans is that the asset you use as collateral is tied to the loan, so you can’t sell it or use it as collateral for another loan until the secured loan is paid off, and there’s always the chance that you could lose it.

While a personal loan is a useful financial tool, there are situations where it makes more sense to just use a credit card. Credit cards use what’s called revolving credit, where funds from the credit card are used as needed and paid off at the discretion of the borrower (beyond a small monthly minimum payment), and interest is only ever paid on money that’s been spent. In contrast, personal loans use what’s called installment credit, meaning that the funds are provided all at once and paid off at a fixed monthly rate over the course of a couple of years. Your credit score benefits from having a mix of revolving and installment credit. The limits on credit cards are typically lower than a personal loan, and credit cards also tend to have lower credit score minimums. The rates for credit cards are usually higher, but you’re only ever charged interest on what you’ve used, making credit cards more cost-effective than personal loans if you are only looking for limited financing. Personal loans are better if you have a need for a bulk of funds all at once. For instance, if you have a considerable amount of credit card debt it may be worth it to take out a personal loan to consolidate your debt and pay it back at a lower rate.

The main difference between a personal loan and a personal line of credit is how the funds are given to you and how the loan is repaid. A personal loan is a form of installment credit in which the funds are given to you all at once and are repaid in fixed monthly installments. Lines of credit operate with revolving credit, which means funds are drawn from it and paid back at your discretion interest only being charged on what’s withdrawn. You will grow your credit score the quickest by having a mix of both revolving and installment credit.

Before you apply for a personal loan, the first thing you should do is consider whether a personal loan works for your needs. If you have a specific purpose in mind for your loan then a specialized loan might be a better choice. For example, if you’re thinking of getting a personal loan to do some renovations on your house, it might be more cost effective to get an FHA 404k renovation loan. Once you decide that a personal loan is what you want, you’ll need to find out what your credit score is. Each of the three major credit checking agencies offers one free credit check a year. After you get your credit report, read it over to make sure everything is accurate, and if there are errors challenge them to get your score to where it should be. You should now look into what loans you qualify for and start comparing options. If the only options available to you are high-cost loans, then it might be worthwhile rebuilding your credit for a period before committing to a personal loan. If you find a loan which suits your needs, and the rates seem appropriate and manageable, apply for it! Personal loans involve less paperwork than a lot of other loans, so applications are quick and straightforward. If you’re approved, you will get your funds straight away. Personal loans give you great flexibility with only a mild increase in price. If there is a loan specialized for your purpose, then that loan is likely a better fit, but if there isn’t, or if you plan to use the money for several purposes, a personal loan might be the best choice for you.