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How to Get a Personal Loan
By Ashley Donohoe MONEY RESEARCH COLLECTIVE
If you have a major purchase coming up or need to cover an emergency expense, you may benefit from getting a personal loan. This type of loan provides you with a lump sum of cash you can use for any personal expense. If you qualify, the loan may come with lower costs and more flexibility than other borrowing options.
Learn about how to get a personal loan, including assessing the pros and cons, preparing your finances, finding lenders and submitting your application.
What is a personal loan?
A personal loan provides a lump sum of cash that you’ll repay through monthly installments. You usually keep the same payment amount throughout your loan term, ranging from one to seven years. In exchange for the loan, the lender charges interest that makes up part of your monthly payment.
Lenders set minimum and maximum personal loan limits ranging from a few hundred to tens of thousands of dollars. Personal loans are useful whenever you need quick money. In addition, these loans are usually unsecured, unlike mortgages and auto loans, so you may not need assets for collateral.
The advantages of a personal loan
One major advantage of a personal loan is flexibility. You won’t encounter rules on what you can use personal loan funds for, and you can typically access a broad range of loan amounts. Some lenders let you take out a personal loan for as much as $100,000. The various repayment lengths also provide flexibility with your monthly payment amount.
Personal loans provide a relatively fast way to get money. You can complete the entire application process online and get the money in your bank account as soon as the next day. Even if you choose a lender with a slower application processing time, you can still expect the funds within a week.
In addition, personal loans tend to have high borrowing limits and more competitive rates than credit cards. Plus, as long as you have good credit, your interest rate may be several percentage points below that of a typical credit card.
The disadvantages of a personal loan
Fees and interest are downsides to getting a personal loan. While interest charges affect any borrower, those with bad credit pay the worst rates. If you can’t keep up with your payments, you risk late payment fees as well. In addition, your lender may charge you fees just for taking out the loan or even paying it off early.
Getting a personal loan also creates the disadvantages that come with any additional debt. Your monthly payment will tighten your budget and potentially require you to make cuts elsewhere. If you experience financial problems, you may default on your payments and damage your credit score.
How to apply for a personal loan
Before applying for a personal loan, you’ll want to know what lenders look for and what you can afford to boost your chances of approval. You’ll also need to explore different types of lenders and personal loan terms before you proceed with the pre-qualification process and, ultimately, your official application.
Check if your credit score needs improving
Your credit score shows lenders how risky it might be to give you a personal loan. If this number is low, you risk getting denied or paying high personal loan rates. While you could still get a personal loan with bad credit, a good credit score of at least 670 is ideal for accessing a good amount of loan options and getting the best terms.
To get your current credit score, you can sign up for a credit monitoring service, buy it through a credit bureau or check whether existing creditors provide you with credit score information. If your score falls short of around 670, consider taking extra time to make timely payments, lower existing debt levels and fix delinquencies in your credit history before you apply.
Know how much of a loan you can afford to repay
Your current income and monthly expenses are important for personal loan affordability and approval. Additionally, different loan amounts, interest rates and terms all affect the payment amount. This means you should look at your budget and use a personal loan payment calculator to assess how much you can borrow.
For example, if you need money for a home renovation, the calculator would show that a $10,000 loan with a 6% interest rate and a five-year term would cost you around $193 monthly. It may be affordable if you have room for this amount in your budget plus some extra cash for unexpected expenses.
Research the best personal loan lenders
Credit unions, online banks and traditional banks offer personal loans, so you have plenty of options to consider. To find the best lender, research financial institutions online and look at their customer reviews. It’s worth avoiding lenders with many customer complaints about poor service or problems during the loan application process.
You can visit a lender’s website to learn about its personal loan options. Pay attention to the interest rates, repayment terms and loan amounts mentioned. Don’t forget to check fees for taking out the loan or paying it off early. Lenders offering the best personal loans are transparent about such costs.
See if you pre-qualify
Once you’ve identified a potential lender, look for the option to submit an online personal loan pre-qualification application. Filling this out lets you see your likelihood of approval and proposed loan terms without a hard credit check that lowers your score. As a result, you can accurately compare multiple options before you commit to a lender.
The pre-qualification form will likely ask for the following:
- Personal and contact information
- Employment status
- Income
- Existing debts
- Housing payment amount
- Desired loan amount and term
- Loan purpose
After you submit your information, the lender may do a soft credit check. You’ll then see your proposed loan offer to decide whether to apply or research other options. If the lender says you likely don’t qualify, you could work on your finances first or research the best bad credit loans.
Decide which lender’s loan terms you like best
Loan terms such as your interest rate, fees and monthly payment amount will vary among lenders. So, compare your different offers carefully to determine which payment amount best fits your budget and which lender charges a competitive interest rate. The lenders may also offer you other term lengths, so weigh any differences in interest rates and payment amounts to decide the best personal loan for you.
If a lender charges an origination fee, consider this an extra cost since it comes out of your personal loan amount. Sometimes, you might find it cheaper to pay a slightly higher interest rate but incur no origination fee.
Submit an official loan application
Completing an official personal loan application requires providing much of the same information as you did for the pre-qualification. However, the lender will expect more details about your income, assets and debts, as well as your payout preference for the loan. You’ll also provide documentation for these items, such as the following:
- Photo identification such as a driver’s license or passport
- Proof of income, such as W-2 forms and pay stubs
- List of your monthly expenses
- Bank, mortgage and credit card statements
The lender will review your submitted application, do a hard credit check and contact you if they need more information or documents. If you get approved, the lender usually deposits the loan amount into your bank account, and you’ll receive information about your first payment due date. The lender should inform you of a denied application so you can take further steps, such as seeking a co-signer or improving your credit score.
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The best places to get a personal loan
Traditional banks, online banks and credit unions are good places for personal loans, but they’re the best for different things. You’ll usually get more competitive personal loan interest rates at credit unions and online banks than at brick-and-mortar banks. However, credit unions require membership and may be less accessible.
Traditional financial institutions offer the most personal touch since you can visit locally. However, an online lender may be the best place to get a personal loan if you want convenience and fast funds.
Personal loan alternatives
While a personal loan can be helpful, it may not suit your situation. You may want a longer loan term or more flexible payments. Here are a few alternatives to consider.
- Credit cards: If you can get a high enough credit line, a credit card can provide you with flexible funds and a smaller monthly payment than a personal loan. The best credit cards often feature 0% introductory financing offers and other rewards too. They are best for short-term financing.
- Personal line of credit: Unlike a personal loan, this option gives you a line of credit that you can use as needed over a specific period. Once the draw period ends, you no longer have access. This credit line suits long-term financing needs.
- Home equity financing: You can borrow from your home’s equity to get a lump-sum loan or line of credit. Although the application process is extensive, this financing option can offer competitive interest rates and a long repayment time. Make sure to repay the loan as agreed, though, since your home will be the collateral.
Important concepts to understand before you begin
When looking at personal loan terms and qualifications, you’ll come across specific concepts. Some of them relate to one-time or ongoing costs you’ll incur, while others deal with loan affordability or the use of collateral.
Debt-to-income ratio
When lenders ask about your monthly income and debts, they use the information to calculate your debt-to-income (DTI) ratio. Dividing your total monthly debt payments by your monthly income helps the lender see how likely it is that you could repay your personal loan.
The lender usually wants your DTI ratio to be no more than 43%. However, a DTI ratio of 36% or less is ideal. Raising your income or reducing your debt payments improves your DTI ratio.
Personal loan interest rates
Personal loan interest rates are often between 6% to 36%. Your specific rate depends on factors such as your credit score, lender, DTI ratio, loan term and borrowed amount. Expect to pay a higher rate if you have a bad credit score, high-DTI ratio, large loan amount or extended loan term. Many lenders charge a fixed interest rate, but others offer variable rates that rise or fall during your repayment period.
Prepayment penalties
Some lenders charge you a fee simply for paying your loan off early since the lender misses out on interest when you do so. The prepayment penalty may be a fixed amount or vary based on your loan balance or interest that you’re avoiding. Since this can add up, always check the fine print for a prepayment penalty and be prepared to look for other lenders if necessary.
Secured loans and unsecured loans
An unsecured personal loan is the most common and doesn’t require pledging some asset to the lender to qualify. This is riskier for the lender, so such loans have stricter qualifications.
Secured personal loans are common for borrowers with poor credit and require you to pledge bank account funds or another asset in case you don’t repay the loan. The collateral reduces the lender’s risk.
Take steps to optimize your approval odds
Now that you know how to get a personal loan, assess your credit and budget to see where you stand. If your credit isn’t great and you don’t need funds immediately, it’s a good idea to take time to improve your credit score. It can help you save on interest and have a better chance of getting approved later.
In addition, consider reducing your existing debts or finding new income sources if a high DTI ratio disqualifies you. Don’t hesitate to pre-qualify through multiple lenders, either, as some may be more willing to work with you.