Personal Loans


Personal Loans - Quick and Easy (for Some)

The Bottom Line: One popular method to get out of debt is a personal debt consolidation loan. Instead of racking up more debt and paying minimum payments, a personal loan allows the borrower to lock into a fixed monthly payment over a few years. However, in order to benefit from a low rate, the borrower needs to have a good-excellent credit score and a clean credit history. When shopping for a loan check for upfront fees, paying close attention to the APR. Avoid bad credit personal loan traps.

Can you imagine taking a loan to get out of debt? Some people will say that is like throwing fuel on the fire. However, many savvy borrowers are turning to personal loans as a great solution to get out of debt.

In order to know if a personal loan is the best solution for you, make sure that you understand how it works, who can benefit from a personal loan, what to avoid when shopping for a personal loan, and the changes you have to make in your behavior for it to work.

One quick piece of advice: A personal loan is not for everyone. In general, a borrower needs good-excellent credit. Before signing on the dotted line or taking out a loan over the internet, make sure that you understand the terms. If you don’t know what fees you’re paying and aren’t sure you can afford the monthly payment, then don’t take a personal loan.

Personal Loans – How They Work

The typical personal loan is a very simple type of installment loan. You take a personal loan for a variety of purposes, including a debt consolidation loan for credit card or medical debt.  Other common usages are home improvements, major purchases, and vacations.

A personal loan is an unsecured loan, which means that the you’re personally liable for the repayment of the loan. You are not providing any collateral as security, such as your home or vehicle.

Most personal loans have upfront costs and are available with fixed rates. When shopping for a personal loan, check out the APR (annual percentage rate, which includes the basic rate plus the fees), which represents the total financial costs. Interest rates (APRs) vary significantly, depending on your credit score and credit history. For example, online rates for a typical personal loan can vary greatly- between 6%-36% as of early 2016.

In order to qualify for a personal loan, the lender requires you to submit an application, consent to a credit report being pulled, and provide some kind of information about income. An online application form will include personal information such as name, birthdate, social security number, email address, address, and telephone number and consent to the lender pulling a credit report.

Overall, the process is simple and easy, and loan funds can be wired within 48 hours, in many cases.

Personal Loans – Who Can Benefit

Anyone looking to get out of debt must consider two important features:

  1. Interest Rate: Is the interest rate on the new consolidation loan lower than the rate for the existing debt?
  2. Monthly Payments: How much can you afford to pay each month? Do you need to lower your payments, or can you make more aggressive monthly payments?

You can benefit most if you have excellent credit and can significantly reduce your interest rate. By combining a lower rate and making constant monthly payments, you can save a large amount of money.

Overall, anyone who can afford to make constant payments at the level of their current credit card payment should consider avoiding minimum payments. They lengthen the payback period and greatly increase the total amount of interest paid.

The example uses these figures, for illustration only:

  • Loan: $15,000.
  • Credit card at minimum payment: Based on Avg. Interest of 16%, minimum payment of 2% of balance and at least $20 per month. The beginning monthly payment would be $300 and gradually decrease.
  • Credit card at fixed payment: Uses same interest rate of 16%, but maintain fixed payments over a four-year period of $425.10 per month.
  • Personal Loan at fixed payment: Fixed payments for 4 years at 9% interest of $373.28 per month.

The graph below illustrates how much a borrower can potentially save by switching to a personal loan. Overall, a personal loan at the reduced rate will save $2,500 over the four-year period,compared to making fixed payments on the credit card. Making minimum payments on a credit card will cost $8,500 more than the personal loan as well as carrying debt for 15 years more than the personal loan.

Personal Loans - What to Avoid When Shopping

A personal loan is a great option for borrowers with excellent credit who qualify for low interest rates and can afford a fixed monthly payment.

Here are a couple of things to avoid:

Bad credit personal Loan: A personal loan in the disguise of a bad credit personal loan or an easy to get payday loan, can be a disaster. If the loan involves paying high interest rates and/or a balloon payment loan, then it is most likely not going to solve a debt problem.

Upfront application fees: Any personal loan that comes with high upfront application fees should be avoided. Quite often, a personal loan includes an origination fee, which is deducted at the time the loan funds are transferred to your account. Law requires the lender, to inform the borrower of the overall costs of the loan including the fee and the interest rate. (This is known as the APR).

Servicing fees and prepayment penalties: Personal loans rarely come with a service fee and usually allow for a prepayment with a penalty.

The personal loan market is very competitive. Banks, credit unions, peer-to-peer lenders, and other online lenders are currently offering personal loans. Rates will vary based on a borrower’s state of residence, credit score, income, and other lender requirements.

Whenever you take a personal loan, shop around for a competitive product from a reliable provider.