Perhaps you're trying to realize a dream you've been working toward for years, or your milestone moment is approaching and it's time to start planning. Or, maybe your life has recently changed, and your financial obligations have evolved with it. Whatever the reason, if you need to access money for personal expenses — whether planned or otherwise — you might consider a personal loan.
This type of financing can help you borrow the money you need for such uses as consolidating high-interest debt. Personal loans can also be used as a way to finance expenses for which you may not have enough cash on hand — or to avoid dipping into your savings.
Before you decide whether to pursue a personal loan, it's important to understand the basics of this type of credit product. To help you decide, here is an overview of personal loans.
What are Personal Loans and How Do They Work?
Generally, personal loans come in the form of lump-sum financing, which means you receive the entire amount of the loan (the principal) all at once from a lender. The lender issues terms with your loan, which dictate your repayment timeline, the interest rate you'll pay on top of the principal, and any fees, such as origination fees to get the loan. Importantly, the higher the interest rate, the more the loan will end up costing you when you complete repayment.
Loan terms vary among lenders. This depends on variables such as the size of the loan and the borrower's credit history. Generally, the stronger an applicant's credit, the more favorable the loan terms will be. This means the loan may be less expensive overall.
Personal loans are generally unsecured financing, which means you don't have to put up collateral to get the loan. In some cases, lenders will offer secured loans, which do require you to use your assets as collateral, such as a home, vehicle, or future paychecks. Secured loans can bolster your chance of approval, especially if your credit score isn't strong enough to get an unsecured loan. Some lenders may offer co-signed personal loans, in which an applicant with strong credit helps guarantee the loan since that person will be responsible for repaying the loan if the borrower does not. Having a cosigner may also make it easier to qualify for financing in some cases.
Understanding your lender and planning accordingly may help increase the chance of your loan approval. The more you know about a potential lender — for instance, what kinds of loans they offer, what benefits may be available (e.g., discounts, automated payments) and if you need to have an existing relationship with them in order to qualify — the less time you'll need to research the details when you need the money. Having a sense of what kind of lender you're looking to work with and their process for evaluating loan applicants can help set you in the right direction.
Do You Have To Explain How You Will Use a Personal Loan?
When applying for a personal loan, many lenders will request that you indicate the loan purpose. Sometimes lenders may offer better rates for certain uses of the funds.
Common Uses for Personal Loans
Personal loans are popular because they help many people address all kinds of financial needs. There are many reasons you might want one, and lots of ways to use them. Here are common uses for this type of financing.
Debt Consolidation
Some people use personal loans for debt consolidation. For instance, leveraging a personal loan for credit card consolidation enables you to pay off other high-interest debt by combining all your existing credit obligations into one monthly payment. A personal loan for debt consolidation may have a lower interest rate than what you are currently paying.
Wedding and Honeymoon Expenses
Some people choose to use personal loans to fund wedding and honeymoon expenses, instead of using personal savings to pay for them. Since personal financing is flexible, you can use the loan to pay for all or just a portion of your celebration expenses, depending on your preference.
Home Improvement
If you need to pay for home improvements, a personal loan can be a good resource. A loan for this purpose can cover improvements such as interior and exterior renovations, and can also help borrowers pay for unexpected repairs.
Travel Expenses
If you are planning a big trip, you may want to use a personal loan for travel expenses. The loan funds can cover parts of your trip including transportation, lodging, food and drink, entertainment, and attractions. You can also keep some of the financing on hand for extra cash while traveling, or leave some aside for any unexpected expenses that may arise during your travels.
Moving Expenses
You can also use a personal loan to fund home expenses. It can be expensive to move to a new home, which is why some people choose personal loans for moving expenses, such as moving supplies, transport, security deposits, and storage. A personal loan can also help pay for ways to personalize your new home with new furniture, decor, curtains, or shutters.
Other Major Purchases
You may find you need financing for any number of major purchases that arise, both planned and unexpected. Since personal loans can cover lots of different expenses — for example, a new computer, a home security system, or exercise equipment — you may find this extra money is the right solution for you if you're considering a purchase that costs more than you'd like to fund from your savings.
What Can't Personal Loans Be Used For?
A major upside of personal loans is that they're generally flexible and enable you to finance a range of expenses. However, most lenders have certain loan purpose restrictions and will not offer a personal loan when the funds are to be used for investing, down payments, certain educational expenses, and business expenses. You'll want to check in with your lender specifically to find out if they have any other specific guidelines or have other options for financing such expenses.
How Do You Get a Personal Loan?
There are several criteria lenders use to evaluate applicants for personal loans. They may include:
- Credit score: Your credit score provides a baseline for lenders to understand your past responsibility with credit, such as credit cards, auto and home loans, etc. There is no hard-and-fast rule for the minimum credit score you need, as this will vary among lenders. However, the higher your score and better your financial standing, the more likely you are to be approved, and the more likely you may be to get better loan terms.
- Credit history: Lenders will evaluate your responsibility with past credit, including how often you make payments in full and on time, how many credit products you have open, etc. They will also look at how much credit history you have established.
- Credit ratios: Lenders may look at your credit utilization ratio, which is how much credit you are using, versus how much credit you have available. The lower your credit utilization ratio, the better. They also look at your debt-to-income ratio (DTI), which is all your monthly debt payments divided by your gross monthly income. These numbers can help lenders see how well you may be able to handle additional debt.
Lenders may also use other factors to evaluate personal loan applicants, such as your existing relationship with the financial institution. Many lenders may consider as a factor applicants with existing accounts — or those who have held accounts with them in the past.
Additionally, different lenders will have different methods to decide whether an applicant is eligible for a personal loan.
If you want to speed up your approval timeline, find the most favorable terms, and have a sense of the amount of money you may be able to borrow, there are a few things you can do. First, it can be helpful to check your credit report in advance of applying for a personal loan, to ensure accuracy or work with the bureau to fix any errors. Some lenders may enable you to pre-qualify for a personal loan, so you can see what your loan terms may potentially be and compare offers. Pre-qualification involves a soft credit check, and it will not impact your credit score.
Additionally, a financial advisor may help you navigate current lending conditions and consider all your options.
Can You Return a Personal Loan If You Don't Use It?
Since many personal loans are lump-sum loans, you can't return the money once you receive the funds. You are required to repay the loan within the repayment period whether or not you use the funds. You can repay the loan immediately or any time prior to the end of the repayment term; however, you are responsible for any interest that accrues during the period of time you have an outstanding loan balance.
If the lender charges a pre-payment penalty, you will also be responsible for paying that fee should you pay the loan off early.
Is a Personal Loan Right for Me?
Personal loans can be a good solution for certain types of purchases, as well as consolidating debt. You can use money from this type of financing to take care of both planned purchases and unexpected expenses and do so with clear terms around repayment. This can be a big help when planning a healthy financial future.
Many people choose getting a personal loan instead of dipping into their cash reserves, to make sure they still have a buffer in their savings. This financing can also be a good option to consider instead of charging expenses with a credit card, since credit card interest rates are often higher than personal loan interest rates.
Final Thoughts
Personal loans are popular for a reason: they're generally flexible as to how they're used and available in a range of amounts. Many people find personal loans useful to consolidate high-interest debt or finance major purchases, whether they are for milestone moments or unexpected expenses. Before submitting an application to a lender, it may help to evaluate your credit health with a financial advisor and find out if a personal loan is right for you. That way, you can plan your spending in the way that's best for you and your finances.
