6 Things You Need to Know Before Taking Out a Personal Loan

Did you know that in 2020 20.9 million Americans had personal loans? And it is likely that the number will only keep climbing, just as it did in the past decade.

Personal loans can be a good place to turn if you are low on funds, want to consolidate high-interest debt, or make a large purchase. Many people take out loans for home remodeling, new cars, or for student debt. However, there are a few important things that you should know about personal loans before you sign on the dotted line, including the following:

Or skip ahead and read about our top personal loan lenders

1. The difference between an unsecured and secured personal loan

Before you take out a personal loan it is first important to understand the types of loans available to you, mainly the difference between unsecured and secured personal loans.

An unsecured loan is the more common type of personal loan, and is not backed by collateral or protected by a guarantor. This can pose a risk to lenders, as there is no protection for them if you are unable to repay your loan. For this reason, interest rates may be higher for unsecured loans and lenders may heavily rely on creditworthiness to determine your eligibility for a loan.

A secured loan is backed by collateral — assets such as a home or a car — which incentivizes borrowers to repay their debt because the lender could seize the collateral if payments aren’t made. In this case, since borrowers are taking a greater risk in putting up collateral, lenders are more likely to accept borrowers with weaker credit scores.

The majority of personal loan companies only offer unsecured personal loans, although some lenders may offer both unsecured and secured loans. Therefore, it is important to ensure that your credit score is in good standing and that you’ll be able to afford a higher interest rate.

2. How interest rates work

Interest rates on personal loans will either be fixed or variable, which will generally only affect your monthly payment amount.

A fixed interest rate means that your rate will stay the same throughout the life of your loan, which means that your monthly payment will never change and you will always know what you owe month to month.

A variable interest rate, on the other hand, will fluctuate throughout the life of your loan, because your rate will be based on the market which consistently rises and falls. This means that your monthly payment may vary throughout your loan term, but your initial interest rate may be lower to account for the fact that it will likely rise some as you’re paying off your loan.

Many personal loan lenders offer both a fixed and variable interest rate option, allowing you to choose what will best fit your needs.

3. Your credit score

When taking on any type of debt, your credit score is a crucial player in determining whether or not you qualify to borrow money, but also decides the rates and terms that you will receive. Although other factors, such as annual income and debt-to-income ratio, may be considered, having a stellar credit score is the key to securing a low interest rate.

Minimum credit score requirements will vary by lender, but a FICO score from 670 to 739 or higher would provide you with greater flexibility in choosing a lender, but could also get you better interest rates. However, top lenders, such as Best Egg or SoFi, may accept borrowers with credit scores as low as 600.

If you do not have an established credit history, or you just have bad credit, some lenders have an option to apply with a cosigner. Applying for a personal loan with a creditworthy cosigner adds an additional, and higher, credit score to your application which can increase your chances of approval and get you a lower interest rate. If this would be helpful for you, be sure to confirm whether or not your potential lender offers this option.

4. What you’ll be using the loan for

Different from a student loan or home loan, a personal loan can be used for a variety of purposes. Thus, when you’re looking into getting a personal loan, it is important to nail down exactly what you are going to use the loan for. The majority of lenders allow borrowers to use a personal loan for whatever purpose they’d like, which can provide some flexibility, but knowing exactly what you need a loan for will help you determine the exact loan amount you will need. 

Unlike home, car, and student loans, personal loans can be used for a variety of purposes, including debt consolidation, home improvement, major purchases, vacations, car financing, wedding costs, medical bills, and business expenses. Some personal loan companies have stricter loan use stipulations than others, so borrowers who are unsure if they will be allowed to use funds for their desired purpose should talk to the potential lender before applying.

One of the more popular uses for a personal loan is debt consolidation, which allows a borrower to combine multiple debts, usually credit card debt, into one in a new loan with better rates and terms.

Michael Micheletti

freedom debt relief; Industry Expert

 

 

Consolidating debt with a personal loan:

Debt consolidation through a personal loan is popular because it can be so effective. For someone with credit card accounts bearing high interest rates, a personal loan could allow them to take out one loan with a lower interest rate, use the proceeds to pay off all the high-interest accounts, and then have just one payment a month for the personal loan (with a lower interest rate).

5. Possible fees

A number of fees may be associated with a personal loan. For example, you could incur application fees, origination fees, check processing fees, late fees, or prepayment fees. It's wise to confirm fees with your potential lender before applying so that you are aware of exactly what additional costs you may have.

6. How to increase your chances of approval

If you are rejected for a personal loan or just want to boost your chances of approval upon applying, there are a few steps you can take:

Clean up and manage your credit

Check your credit report for errors that could be hurting your overall score, and get on top of payments if you haven’t already. Making consistent on-time payments is one surefire way to increase your credit score and bolster your credit history.

Boost your income

Some personal loan lenders will also take a look at your income when considering you for loan approval. This can be helpful if you have less-than-perfect credit but a steady income; but, if you have a low income, this could make it difficult to qualify for a personal loan. Thus, you could seek to boost your income by taking on a side hustle or another job.

Take care of other debt

When you are looking to take out a loan, which is essentially more debt, it can be helpful to pay down and manage other debts you may have. Paying down debt combined with increasing your income can increase your debt-to-income (DTI) ratio, which could improve your chances of approval.

Apply with a cosigner

Another option is to apply for a loan with a cosigner, adding another and stronger credit score to your application. A cosigner provides a lender with greater assurance that payments will be made since the cosigner would be responsible for paying off the debt if the borrower can’t. 

Applying with a cosigner could improve your chances of approval, but also help you get a lower interest rate. 

It is important to note that not all lenders accept cosigners. Make sure you check with your lender to see if this is an available option.

Find the right lender

Not all personal loan lenders are the same. Therefore, it is important to do some research and comparison so that you can find the best lender to fit your needs. Consider your credit score, what loan amount you would need, whether you’ll need to apply with a cosigner, etc. These factors can vary between lenders, and you might have a greater chance of getting approved with one than another.

While these aren’t necessarily your only loan approval boosting options, they can be a good place to start.

The Importance of Comparing Lenders

An important factor in getting a personal loan is taking the time to compare lenders, allowing you to find the best interest possible.

Most personal loan lenders have a prequalification process with a soft credit pull which shouldn’t impact your credit score. This can allow you to prequalify with multiple lenders and to compare the rates and terms you receive.

The Top Personal Loan Lenders

Best Egg

On BestCompany.com, Best Egg is a consumer favorite, with 98 percent of reviews awarding the company 4 or 5 stars overall.

"This was my second experience with Best Egg, and it was even easier this time around. They were fast, effective, and delivered the results and help I needed. Thank you!"

- Eric, July 9, 2020

Best Egg’s personal loan services and options are competitive in the industry, accepting a lower minimum credit score than the majority of other lenders and offering low rates.

Customers speak to these features in their reviews but also highlight the speed and simplicity of Best Egg’s application and approval process, in addition to superior customer service. Many customers say that they would recommend Best Egg to their friends and family.

Read more Best Egg reviews

FreedomPlus

With 90 percent of customer reviews awarding FreedomPlus 4 or 5 stars, the company could be a good choice for your personal loan needs. 

Many reviews highlight great experiences with customer service in which they received the help they needed in a timely and professional manner. On the flip side, some reviews also detail bad experience with customer service in which they were told conflicting information and did not receive the help they wanted and/or expected. Beyond customer service, customers do highlight speed and simplicity in the FreedomPlus application and approval process.

"It was easier than I thought it was going to be to get the loan. What a relief to get the help to pay off my credit card debt. Customer service rep, Terrance, was very helpful and informative. FreedomPlus so far so good."

- Jessica, October 31, 2019

Read more FreedomPlus reviews

SoFi

SoFi is another top personal loan contender, pulling in 4 and 5 star reviews from 96 percent of customers who have left reviews on BestCompany.com. 

It is important to note that the majority of reviews are somewhat outdated, but many of these reviews highlight a quick and easy loan process and low rates, in addition to responsive and helpful customer service.

"Quick, easy loan process and competitive rate. The customer service throughout the process has been fantastic! Immediately answered my calls and provided solid info. Much easier to navigate than any other loan."

- Matt, December 14, 2018

Read more SoFi reviews