See the results of our 2022 Personal Finance Study!
8 Questions to Ask Before Taking Out a Personal Loan
Taking out a personal loan is a big decision. It impacts your credit, increases your debt load, and you're obligated to make fixed monthly payments for a specific time period. However, personal loans can be a lifeline when your finances need a boost, such as with consolidating high-interest credit cards or dealing with an emergency. Before you take out a personal loan, read through these personal loan questions and answers so you can make an informed borrowing decision.
What is My Credit Score?
Understanding what your credit score is before applying is vital to the overall process. This is because your credit score is one of the biggest determining factors for both approval and the interest rate you're quoted. It can even impact how much you're allowed to borrow.
You can check your own credit report for free and it's a good idea to do it before you start the application process. If you have time, you can work on improving your credit score to better your chances of borrowing and getting a more favorable interest rate. Plus, if there are any errors on your report then you can work on getting them removed. Improving your credit score can bump you up into a better credit score range, which means your interest rate may be lower and you may have higher borrowing limits.
What Can I Use a Personal Loan for?
One of the numerous advantages of a personal loan is the flexibility it provides with funding. You can use the lump sum from a personal loan for virtually any type of family or household expense. It's a good idea to confirm if the lender has any restrictions, such as for educational loans, but most allow a wide range. Some examples of uses include:
- Home repairs or improvements
- Consolidating high-interest credit card balances
- Medical bills
- Moving expenses
- Funeral expenses
What are the Types of Personal Loans?
Personal loans fall into two main categories:
- Unsecured personal loans: An unsecured personal loan means you don't have to provide any collateral to borrow money. The lending decision is based on your credit score and income instead. This makes it more difficult to qualify for this type of loan but you won't be risking any personal items if you miss payments.
- Secured personal loans: Collateral, such as a vehicle or real estate, is used to borrow money with a secured personal loan. These are less risky for the lender and you may qualify for higher borrowing limits depending on the collateral.
How Much Should I Borrow?
The amount you should borrow depends on how much you need for your financial goal and how much the lender is willing to approve. Lenders will have a borrowing limit depending on your credit score and other factors. However, it's in your best interest to only apply for the amount you need since you will be responsible for a monthly payment with interest.
Borrowing ranges vary widely by lender, with some as little as $500 and others as much as $50,000 for a personal loan.
How Much are Interest Rates for Personal Loans?
Personal loan interest rates vary from one lender to another. This is one reason why it's important to shop around and compare lenders when possible.
Interest rates are based on multiple factors, including, but not limited to: your credit score, credit history, debt-to-income ratio, and your overall financial profile. In general, the better your credit score, the better interest rate you'll receive. However, if you have bad or fair credit, don't be discouraged. There are lenders who specialize in working with borrowers with lower credit scores, but you can expect higher interest rates and fees.
According to the National Credit Union Administration, as of September 2022, the average interest rate for a 36-month unsecured personal loan with a bank was 10.16% and the national average rate with a credit union was 9.15%.
How Much is a Monthly Payment for a Personal Loan?
Personal loan monthly payment amounts depend on several factors, including but not limited to: the amount you borrow, the interest rate you secure, the number of months (or years) you have for repayment, and any other fees rolled into the cost of the loan. It's a smart idea to understand your monthly obligation before you sign on the dotted line so you can determine if it will work with your monthly budget.
What Documents Do I Need to Get a Personal Loan?
The exact application process will depend on the lender, but you can expect to provide personal information to close on the loan. You can provide this either online or in-person, depending on which lender you're working with.
You may find it helpful to gather the documentation beforehand and have it all in one place as you work through the application process. Most lenders require you to submit:
- A copy of your government ID, such as a driver's license
- Your social security number
- Proof of residence
- Proof of income, including bank statements, W-2s, and tax returns
Are There Alternatives to Personal Loans?
Taking out a personal loan has many benefits, such as fast funding times and flexible use of funds. There may be other borrowing alternatives worth considering though, including:
- Personal line of credit: You can take out personal lines of credit from either a bank or credit union, and this can be a convenient option if you already have an established relationship. Once approved, you borrow the funds only as you need them, which means your monthly payment will vary depending on how much you've borrowed and the repayment terms.
- Low-interest rate credit card: If you need a smaller amount of funding then a credit card may be a reasonable solution. If you have a large purchase or need to lower an existing interest rate on another credit card balance, then look for cards offering a 0% introductory offer for purchases or balance transfers.
- Peer-to-peer lending: This is an option to raise funds from individual investors instead of a financial institution, and is usually conducted through a third-party platform.