Loans are usually tied to a specific purpose. A mortgage is used to buy a house, a car loan is used to buy a car and student loans are used to fund a college education. In most cases, the loan is tied to a specific product that can be used as collateral.
But personal loans are more versatile. A personal loan can be used for everything from a home gym to heart surgery, and have less stringent qualifying procedures than something like a mortgage. That can be dangerous territory for someone with a bad credit history, but it’s a great option for a responsible borrower in need of some quick cash.
If you’re curious about personal loans and how they could help you, read ahead to find out.
What is a Personal Loan?
A personal loan is a catch-all term for loans that are unsecured or don’t have any collateral behind them. Personal loans can be used for a wide range of reasons, such as medical bills, engagement rings, home improvement projects, vacations and more.
Many people use personal loans to consolidate their debt, because rates can be low if you have sufficient credit. For instance, someone running a $10,000 credit card balance with 20% APR could probably save hundreds on interest by paying off that debt with a personal loan.
Personal loans often have terms between one to five years, with interest rates ranging from 5% to 36%. The loan amount is usually between $5,000 and $35,000, but can sometimes be for as little as $500.
Interest rates on personal loans vary based on the term, amount lent and the borrower’s credit history. Borrowers should have a credit score of at least 580 to be approved for a personal loan, though scores of 740 or higher will result in lower interest rates.
Personal loans are available through some banks, credit unions, and online lenders. Each will have their own interest rates and fees, so it’s important to compare the total costs before signing up.
Predatory lenders are very common in this market, so it’s important to read the fine print closely or borrow from a well-established institution. Some lenders will entice desperate borrowers with a reasonable interest rate, only to gouge them with fees. Besides interest rate, fee structure is the most important thing to look at when shopping for a personal loan.
One of the most common fees is the origination fee, which a lender charges to open the account. Not every bank has origination fees, but those that do charge between 1-8% of the loans’ amount. Another avoidable fee is the prepayment penalty, which a bank charges if you repay the personal loan ahead of schedule.
How They Can Help
Personal loans are a viable alternative when you need money and don’t want to rely on credit cards. When you run a balance on a credit card, there’s no fixed due date for repaying the debt. As long as you make the minimum payment every month, the credit card company won’t hound you to repay it in full.
When you take out a personal loan, the lender gives you a specific end date. This often means you pay less interest overall with a personal loan than with a credit card. You also receive the money in your checking account as a lump sum, sometimes as soon as 24 hours after your application is finalized.
Here are some of the most common reasons people use personal loans beyond debt consolidation:
It’s a common scenario: you buy a house and decide to do some renovations before moving in. After moving, buying new furniture and saving for the down payment, you don’t have any cash left. Because you just bought the home, you don’t have enough equity for a home equity loan or line of credit. Taking out a personal loan to pay for the repairs is one of your only options.
Some people even prefer personal loans over home equity loans or HELOCs because the house isn’t used as collateral against the debt. Your credit score will tank if you default on a personal loan, but the bank can’t repossess anything. If you default on a home equity loan, the lender can evict you and sell your house to recoup their money.
The average wedding costs $33,391 according to wedding website The Knot
. Saving that amount of money can take several years - time that no couple wants to spend waiting.
If you have a steady job, you can apply for a personal loan to pay for wedding expenses. You can also use a personal loan to pay for an engagement ring or honeymoon.
According to Moving.com, the average cost of a cross-country move is $4,300
. Even if you’re moving for better job prospects, the prospect of spending thousands of dollars before your first paycheck can be daunting.
A small personal loan of $5,000 can be enough to get you settled until your first paycheck. The personal loan will keep you afloat until your employer reimburses moving expenses, which can take several weeks to show up on your paycheck.
Opening a New Business
Starting a new business is another popular reason for taking out a personal loan. Business loans can be difficult to come by for new businesses, especially if they’re not yet producing revenue. Even if you do qualify, the lender might require something like a house or retirement account as collateral.
Thankfully, there are less stringent requirements for a personal loan. If you’re struggling to qualify for a business loan - or don’t want to tie your personal assets to company debt - a personal loan can be a great choice.
Pay for Medical Bills
According to a 2017 Discover personal loan survey, medical bills were the most common reason for taking out a personal loan
. While some providers offer payment plans, others need to be paid in full before the procedure or immediately after.
In this kind of situation, it’s better to worry about your health first and repaying debt second. If you don’t have enough saved for an important procedure, a personal loan can get you back on the mend faster.