It’s true that money can’t buy happiness, but there are plenty of things money can buy, be it the perfect house or paying for an unprecedented emergency room visit. When these situations happen and we don’t have the money, there are a couple of options to secure the finances to keep life moving on. One of them is a personal loan, usually from a bank. Here are a few things to keep in mind before you start borrowing for a life event.
1. Types of Loans
Personal loans typically are characterized by borrowing a fixed amount of money and repaying a fraction of the amount along with the interest each month until the entirety of the loan and its interest is paid off. Out of personal loans, there are two types, secured or unsecured. Both use different ways of holding the borrower accountable for paying back the loan; the difference depends on whether the lender collects collateral. With secured loans, the lender asks for collateral (think house or car or a savings account). Unsecured loans are when the lender determines beforehand whether someone meets the qualifications of borrowing. Usually the qualifications involve a credit score.
The typical place to apply for a personal loan is a bank, but other options include credit unions, consumer finance companies and online lenders. This article on Credit Karma by Jennifer Brozic discusses more options and also sheds a bit of insight into online lenders.
2. The role of your credit score
Not only can your credit score determine your qualifications for a loan, it also receives an impact when you apply for a loan. Regarding eligibility requirements, a good credit score not only means it’s more likely you can apply for an unsecured loan, it also might mean you get a lower interest rate. Diane Moogalian from Equifax talks more about the benefits of having a good or excellent credit score.
There are a number of ways in which your credit score can change. For example, when lenders conduct a hard inquiry (pulling your credit report and score in the lending application process), your credit score typically drops by a few points. However, paying your loan repayments on time each month can help you maintain a good credit score. When you’re still researching loan options, you can see if you’re prequalified for an offer. In this instance, institutions may run a soft inquiry. Once you submit an application, then the institution will run a hard inquiry. Read more about the difference between soft inquiries and hard inquiries in this article by Tim Devaney on Credit Karma.
3. It’s all about interest
The state of your credit score affects the interest a lender offers. The interest rate also depends on the reason you’re taking out a loan. For personal loans, the rate for Q1 2018 was 10.22 percent. If you plan to take out a loan to buy a car, it’s better to categorize your loan as an auto loan to get a better interest rate at 4.74 percent (also numbers from Q1 2018). Ben Luthi from Credit Karma provides more information on how to find the best interest rate for you in this article and shares general tips, include comparing interest rates maintaining a good credit score.
4. Fees to look out for
Interest rates aren’t the only thing to look out for. Because most banks intend to make a profit from your loan, there may be additional fees associated with the loan such as an origination fee or an application fee. When researching low interest loans, take the time to ask about any additional fees. If the origination fee is more than 2 percent, it’s a good idea to reconsider the loan. This article on Bankrate by Donna Fuscaldo includes more information on origination fees and what to be aware of.
Applying for a loan may seem like a daunting task due the number of things you need to consider. Initially, you should compare loan offers from several institutions and make note of the interest rates, origination fees, and application fees. It’s also important to understand the impact of loans on your finances, particularly your credit score. We may not be prepared for everything life throws at us, but the least we can do is understand the process of applying for a loan if and when the need arises.