7 Important Things to Know About Personal Loans
Thinking about personal loans can be a stressful situation. Often times, we approach it as though it is a bad thing. It is almost like “here I go again, I need something I cannot afford”. While there are times when that is true, it does not always have to be bad. A personal loan can be a good thing for you and your financial picture. The key is that you must use it properly and for the right things. I am going to help you understand the good and bad ways to use a loan. Personal loans are not something you should fear, but there are some important things to know about personal loans. Keep reading as I dive a little deeper into the top 7 things you should know about personal loans.
What Is A Personal Loan?
Before we can talk about all the things to know about personal loans, it is important that you fully understand a personal loan. A personal loan in its most basic definition is a fixed amount of money that someone lets you borrow. You promise to repay that amount of money plus a little extra every month until the loan is paid. Seems fairly simple, right? Well, there are some details that I brushed past that are important for you to understand. That someone letting you borrow money is a lender and it is typically some type of financial institution. Personal loans go by many names. You may hear it referred to as consumer installment loans or an unsecured loan. These are all still personal loans.
I mentioned plus a little something extra. That is called interest. The amount of interest you pay changes based on the lender and on your credit. We will come back to credit in a bit. The amount you pay back each month remains the same and you pay it back for anywhere between three to five years. This is all determined before you sign the loan contract. There is often a bunch of fine print. Be sure you read all of that.
Are There Different Kinds Of Personal Loans?
I mentioned earlier that a personal loan goes by many different names. There are also many uses for personal loans and some different types of loans. These are also things to know about personal loans when deciding what to do. You can use a personal loan for just about anything you want. A lender asks you the purpose of the loan, but that really is not a factor in your approval.
Personal loans are often used to consolidate debt or to pay off major medical expenses. When you find yourself in an emergency situation and you are short on cash, a personal loan may be the answer for you. It is important to remember that a personal loan is not the long term answer. You have to pay back the loan each month, so it is important to make sure you can afford to pay it back. Today it is much easier to apply for a loan. You can even get personal loan online in a matter of days. There are loans such as payday loans and cash loans bad credit.
The Thought Of A Personal Loan Scares Me
That is completely understandable. Obtaining a personal loan and adding more debt to your life can be a scary thought. The key is to know everything you can about personal loans. When you truly understand the personal loan process, the thought of it is less scary. Understanding all the things to know about personal loans helps you make an informed decision instead of an emotional one.
Remember that a personal loan can help you improve your financial picture when used properly. If your credit is not that great, it can help you improve your credit score when you make your payments timely. A personal loan can help you consolidate your debt so you can focus on one payment instead of multiple smaller payments. This can help you decrease your total amount of debt faster because you can focus on just one debt. It also helps you mentally by focusing on just one bill to pay instead of attempting to pay many different bills.
Important Things to Know About Personal Loans
If you decide to take out a personal loan, you should definitely explore the entire process to get to know the benefits and the disadvantages. But there are some key things we decided to point out, so you’d know what to pay special attention to.
Important Thing To Know About A Loan #1 – Credit
I know this is a topic that few people ever want to discuss. Even the mention of the word credit concerns people. Credit is definitely an area where the more you know, the better you are. This is one of the top things to know about personal loans. I am going to start with basics when it comes to credit.
Your credit score is a three-digit number that appears on your credit report. There is a difference between your credit score and your credit report. Your credit score is on your credit report. Your credit report shows your credit history. It lists all your debts and it shows your payment history, the good and the bad. Items tend to stay on your credit report for 7 to 10 years. It takes a long time to build your credit, but just a few missed or late payments send it plummeting.
A typical credit score ranges from 350 to 850. Most people have a credit score somewhere between 600 to 750. Good credit falls somewhere between 670 to 800. Anything below 570 falls into the danger zone of bad credit. When you have bad credit, it is much harder to get a good interest rate. You may find it is difficult to be approved for a loan, if you have bad credit. It is still possible to get a loan, but you have to work harder and do more research.
What Do I Do If I Have Bad Credit?
One of the important things to know about personal loans is that your credit is the reason personal loans are commonly denied. You should pull your credit report and look at your credit score once a year. This helps you remain in control of it. You can also check it for errors, so you can address them. If there is an error on your credit report, you must take steps to correct it. If you do not know your credit score, you cannot do anything to improve it. You can reduce the amount of debt that you have.
Lenders look at something called a debt to income ratio. This is the amount of debt that you have compared to the amount of income you have. You need to lower your debt to help improve your credit score. Another thing you need to do is begin to create a positive credit history. You can do this by making sure that you pay all of your bills on time and for the correct amount. Late and missed payments are the leading cause for a poor credit score.
Another factor that hurts your credit score is your income and job history. If you have low income, you should work hard to improve that, or find an additional job until you can improve your credit score. Lenders look at the amount of time you have been working for the same employer as part of your credit history. When you have one employer for a long time that shows them you are stable. When you bounce from job to job in short periods of time, or have periods of no employment, that makes then think you are not stable. This makes them think that you are not a good candidate to pay back a loan.
Important Thing To Know About A Loan #2 – Income
Since we are talking about employment history, let us talk a little deeper about income. You may not realize just how much that impacts your ability to obtain a loan. Add this to the list of things to know about personal loans. Not only does a lender want you to have stable employment and a good income, but they also want you to prove it to them. Lenders require you to show proof of income for personal loans if they think they might consider approving you for a loan. The most obvious proof of income is a pay stub, but not everyone has typical employment. There are many people who are self-employed or do contract work or possibly even receive payment in cash. They still need to show proof of employment.
Other ways to show proof of employment are a W2. This is a tax document that shows how much money you have made in the previous year. This, however, may not show the income that you received in cash. You can use a tax return as proof of income. This document shows all of the income that you claim, along with any losses that you claim. You must remember that this document shows only the income you claim. You have made income and you are not reporting it as such, it does not show up on your tax documents. Doing so may also cause you problems later with the Internal Revenue Service (IRS), so I would not recommend you do that.
Lenders may also accept bank statements as proof of how much money is going in and coming out of your bank account. It shows your deposits which could be income. Again, this document only shows money that is deposited into your account. If you have cash or money is being deposited elsewhere, it will not show up on that bank statement.
Important Thing To Know About A Loan #3 – Interest Rates and Fees
Interest rates are an annoying thing that always accompanies a loan you get from a lender. Rates and fees are absolutely things to know about personal loans. They can make a big difference in the amount of money you are paying back each month. I am going to list for you some of the common fees and terms you should look for when it comes to personal loans.
- Principal amount – this is the actual amount of money you borrow. The lender adds interest on to this amount. Typically, lenders have a maximum amount they lend for a personal loan.
- Interest rate – this is a percentage of your loan. This is added on top of your principal amount you borrow. They are usually a fixed rate. They can be anywhere from 7 percent to 30 percent depending on your credit.
- Term length – this is the amount of time you are paying back the loan. They are usually fixed, so unlike credit cards, you pay the same amount each month.
- Prepayment penalties – this is the amount some lenders charge if you pay back the loan before the end of the term. Remember the lender makes money based on the amount of interest they charge. When you pay off the loan sooner, ultimately you are paying less interest and the lender is making less money. They do not often like that. Be sure to read the fine print to determine if there are any early repayment fees.
- Additional fees – always read the fine to understand any fees you may pay. A lender must disclose all fees and penalties in the contract before you sign it. It is, however, up to you to read it. Be sure to look for any origination fees, application fees or service charges.
Important Thing To Know About A Loan #4 – Documents
Lenders require many documents in addition to the proof of income we talked about earlier in this article. These are things to know about personal loans before you apply for a loan. If you understand what documents you may need to provide, you can work to get them together and have them ready. This may shorten the length of time for your waiting period while the lender makes a decision on your loan.
Lenders require documentation such as proof of identity. It is important that the lender knows you are who you are claiming to be. With all the identity theft out there today, they cannot be too careful. This is put in place to protect you and the bank. You often must provide a drivers license or some other form of picture ID. That could be a passport, military ID, or state ID. Please make sure that this identification card is not expired. They do not accept expired documents. The lender may also ask to see your Social Security card. This tends to be an optional document only if they need other supporting documentation to verify your identity.
You want to make this process as easy as possible for the lender. Remember, you are asking them if you can borrow money from them. You should provide them any documentation they need. These documents are in addition to the ones we discussed earlier, such as paystubs, tax returns and bank statements.
Important Thing To Know About A Loan #5 – Defaulting On A Loan
Let us talk about defaulting on a loan for a minute. I do not want to spend much time on this because it is something you should avoid at all costs. However, being in default is one of those things to know about personal loans. Basically, when you default on a loan it means that you are not paying the loan. Lenders differ in their definition of default. Some lenders say it is one missed payment. Other lenders give you a grace period of several months before they say you are in default.
No matter what your lender considers default, you want to avoid it. You should also know that a lender will get its money. It does not matter what that lender has to do. They may turn you over to a collections company. Or, they may sue you. They may take you to court and have your wages garnished, but they get their money.
You should focus on always paying your bills on time. If you are not able to pay your bills, then you should be honest with the lender. Call them and let them know you are having difficulty paying the bill. Most of the time a lender is wiling to work with you. It does not benefit them when you do not pay your bills. If they can set up a different payment plan with you, they will make every effort to do so.
Important Thing To Know About A Loan #6 – Pre-Qualified
Pre-approval and pre-qualified are confusing terms that lenders like to throw around a lot. They are things to know about personal loans, so I want to talk about it a little bit. You probably have received those invitations in the mail from lenders stating that you have been pre-qualified and pre-approved. When a lender says you are pre-qualified, it means they have done a soft hit to your credit. That means that lender has looked at your information, but hasn’t done anything that would impact your credit score. The lender took a quick look at your information and believes that you may qualify for a loan with them. However, this does not guarantee your approval. You can still be denied when you apply for the loan and the lender pulls your full credit report.
A hard pull of your credit report requires your approval because it is a hit to your credit report. The lender is able to see everything on your credit report. At times, you may receive a pre-approval from a mortgage company. This is important when you are trying to buy a home. These often are more of a guarantee of approval. For a personal loan, you do not often get those guarantees.
Important Thing To Know About A Loan #7 – Loans For Bad Credit
Earlier in this post I talked about credit and mentioned that if you have bad credit, you have to work a little harder to get a loan. That is still true. Bad credit does not stop you from getting a loan, but it makes it harder. It is one of those things to know about personal loans. Do your homework and it can save you a lot of money in interest and fees. You know that your interest rate is based primarily on your credit score. Also, you know that you can improve your credit score, but it takes times and consistent effort. You do not have time because you need the loan know.
In these cases, you should look for lenders other than a typical bank. Credit unions often cater to those with less than perfect credit and their interest rates tend to remain reasonable. You can apply for a loan with an online lender. The application turn around time is just a few days. It is fast, but often comes with a higher interest rate. Be cautious not to get sucked into fast cash loans bad credit that you cannot afford. It may be tempting but remember you always have to pay it back per the terms of the agreement. If you are not able to do that, walk away from that loan and find another one that fits for you.
We Can’t Forget Budgeting
Since we are talking about a loan that fits for you, it makes perfect sense to talk about budget. You probably thought you would get through this article without having to talk about a budget, didn’t you? Guess what? It is not going to happen. Creating a budget is important and if you do not have one, you need one. If you have one, you need to follow it. This is one of those important things to know about personal loans.
A budget helps you determine how much of a loan you can afford to pay back. You should start by simply writing down all your expenses in one column and all of your income in another. Add up the expenses and if it is more than your income, you cannot afford to pay back a loan. Not only that, but you should begin to decrease some of those expenses. Maybe you can do that with a consolidation loan, depending on the expenses. Maybe you can remove some of the things you are paying for each month.
For example, do you buy lunch everyday? Maybe you can take your lunch instead of buying it and see how much money that saves you per month. I am willing to bet that small change could save you almost $300. You can make simple changes that make a huge impact on the amount of money you have each month. You may determine that by cutting some costs, you do not even need a loan. But, you cannot do these things until you actually sit down and begin to look at how much money you are spending each month.
Do not look at it as a bad thing. Think about it as you taking control of your money and your life. This is an opportunity for you to be in control instead of your money controlling you. It is a powerful place to be and it feels really good. One of those things to know about personal loans is that you always have to pay it back. It is not free money.
In all this talk about the things to know about personal loans, I did not talk much about your ability to afford the loan. It is incredibly important that you make sure you can afford to pay back the loan before you apply for it. You should not enter into a loan contract lightly. You should take the time to consider if this is the right decision for you. If it is and you can pay it back, go for it. However, if you know you cannot afford to pay back the loan, you should stop here.
In all the things to know about personal loans, it is key to remember that you have to make a monthly payment until the loan is paid. Most often, that first payment is within 30 days of you receiving the money. There is not a grace period. The lender want their money to come back to them quickly. You do not want to negatively impact your credit because you took out a loan that you already know you cannot afford to repay. You should look into other options if a loan is not the right one for you.
Julia Peoples is a long-time business manager focused on providing decision making assistance to the public. She works with people at key points of their lives who are making important retirement and financial decisions. She has had many articles published that educate the public on sound financial decision making.
Julia writes for those who are working towards financial freedom or a better understanding of how finances work. She has shared her financial insights with individuals on a one on one basis for years.