Published in: Personal Loans | Aug. 24, 2019
4 Things to Know Before You Apply for a Personal Loan
By: Christy Bieber
Borrowing money is a big decision. Don’t apply for a personal loan until you know these key things.
Thinking about getting a personal loan? Before you apply, it’s important to know a few key things about how personal loans work and what loan terms you might be offered. In particular, you’ll want to know four key things: what personal loans can be used for, how funding works for personal loans, what affects your personal loan rate, and how your loan will be paid back.
As this guide will explain, personal loans can be used for any purpose, although they are often used for debt repayment and big purchases. Funds are received in one go, and your interest rate and borrowing costs will vary based on your credit score, income, and which lender you select.
You’ll find out your payment term up front, and many loans are paid back on a monthly basis over several years.
What can personal loans be used for?
When you take out a personal loan, you have flexibility in terms of what the funds are used for. Most lenders don’t even ask you what you’re going to do with the money.
Debt consolidation is one of the most common uses of personal loan funds because personal loans often have lower interest rates than those of credit cards and other kinds of debt. If you want to buy something and you can’t afford to pay for it in one go, a personal loan may also be a good way to finance it -- if you can qualify at a lower rate than a credit card would charge you. And, you can even use a personal loan for home improvement expenses.
Although you can use a personal loan for anything, there are some situations where you may be better exploring other sources of financing. If you’re looking to borrow for school expenses, for example, federal student loans have borrower protections that are not available for other loans, and the interest rate may be lower.
You may also get better rates on an auto loan rather than using a personal loan to buy a car. And a home equity loan might be preferable for those home improvements because the interest rate is usually lower, and you might be able to claim a tax deduction on the interest.
A note of caution: even though you can take out a personal loan to spend as you wish, it’s still a bad idea to borrow for unnecessary purchases. The interest costs of personal loans will make those unnecessary purchases even more expensive, and committing to a monthly payment for something you don’t need can adversely affect other financial goals. So, try to avoid borrowing for vacations or other things that aren’t necessities.
How does funding work for personal loans?
When you apply for a personal loan, you’re approved to borrow a set amount of money. Different lenders have their own minimum and maximum loan amounts, but your specific financial situation determines how much you’re allowed to borrow within those parameters.
You cannot borrow more from the personal loan, even as you pay down what you owe. This makes personal loans different from revolving lines of credit, such as credit cards or home equity loans.
With a personal loan, you will receive the money all at once, in one lump sum. After you’ve applied for the loan, some lenders can provide this funding as soon as that same business day, or the next one. Others will take a week or more to get you your funding.
What affects your personal loan rate?
Personal loans often have lower interest rates than credit cards, but there’s a ton of variation in personal loan rates. Many factors affect the rate you’re likely to pay on your loan including:
- Your credit score: If you have a high credit score, you should be approved to borrow at the most competitive rates. If your score is low, you may not be able to borrow at all or may be limited to taking out an expensive personal loan from lenders willing to overlook past borrowing mistakes.
- Your income: If you have solid proof of income, you’re a more attractive borrower and may be offered a better rate.
- Whether you have a co-signer: If you have a co-signer with better credit or more income than you, your co-signer could help you qualify for a loan at a competitive rate.
- Your loan repayment term: Loans with longer repayment terms usually have higher interest rates than loans with shorter repayment timelines.
- Whether your rate is fixed or variable: Fixed rate personal loans often start at a higher interest rate than that of variable rate personal loans. But, variable loan rates are tied to financial indexes, and can move up or down over time, which means that your rate could end up going up.
- Which lender you select: There’s variation among different lenders, even for borrowers with the same credentials. That’s why it’s so important to shop around and get rate quotes from multiple lenders.
How are personal loans paid back?
When you borrow money from a personal loan lender, you agree to a set repayment schedule up front. Your repayment timeline could span anywhere from a few months to a decade or more, although many personal loans are repaid over three to five years.
Monthly payments are calculated based on the amount of principal and interest needed to repay the loan within the designated repayment timeline. A shorter repayment term will typically mean a larger monthly payment since you have less time to repay the loan. Higher interest rates also mean larger monthly payments.
If your personal loan has a fixed interest rate, you’ll pay the exact same amount every month until the loan is paid off. If the rate is variable, monthly payments could go up or down depending on the movement of the financial index your loan is tied to.
Now you know four key things about personal loans
Now you know four key facts about personal loans that will help you decide whether these loans are the best way to borrow. If you’re looking for a loan you can pay back over several years and use for any purpose, personal loans may be right for you -- but your credit score and the lender you select will affect the cost of borrowing and the repayment process.
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