Content of the material
- What is an installment loan?
- Know Your Rights Under Regulation Z
- Decide Where to Borrow Money
- Decide on a Bank Loan Amount
- Using collateral
- What it is
- Tips to keep in mind while applying for a personal loan
- How to Qualify for a Personal Loan
- Alternatives to bank loans
- Tips for speeding up the process
- 4. Collateral
- More about Personal Loans
- How to apply for a federal or private student loan
- The application process for a federal student loan
- 3. Know that loans can actually boost credit scores
- Home equity line of credit Upgrades? This one’s on the house.
- 5. Make sure your bank offers personal loans
- A personal loan to pay off debt
- The Bottom Line
What is an installment loan?
When people mention personal loans, they’re often talking about a type of installment loan where you borrow a certain amount of money up front and agree to pay it back a little by little over a set period of time.1
Each payment is usually called an installment. For example, you might have a monthly payment, or installment, of $300. You’ll typically owe that amount each month for a certain number of years until you pay back the full amount.
Know Your Rights Under Regulation Z
In 1968, the Federal Reserve Board (FRB) implemented Regulation Z, which, in turn, created the Truth in Lending Act (TILA), designed to protect consumers when making financial transactions. Personal loans are part of that protection. This regulation is now under the auspices of the Consumer Financial Protection Bureau (CFPB).
Subpart C–Sections 1026.17 and 1026.18 of the TILA require lenders to disclose the APR, finance charge, amount financed, and total of payments when it comes to closed-end personal loans. Other required disclosures include the number of payments, monthly payment amount, late fees, and whether there is a penalty for paying the loan off early.
Decide Where to Borrow Money
Once you have an idea of your credit, loan type, and loan amount, shop around for a lender. The Balance provides lists of the best mortgage lenders and personal loan companies so that you can compare individual lenders.
Again, the type of loan you want may dictate your choice of a lender. Some institutions don’t offer business loans or student loans. Start your search at the institutions that are best known for making affordable loans of the type you want. For example, go through your school’s Student Aid office for an education loan before you go to the bank for a private student loan.
Banks and credit unions are a good place to shop for most loans. Check with several institutions and compare interest rates and costs. Peer-to-peer loans and other sources of marketplace lending should also be on your list. Online lenders provide another option but stick to reputable sites if you go this route.
Some people borrow money from private lenders, such as friends or family. While that can make approval easier and keep costs low, it can also cause problems. Make sure you put everything in writing so everybody’s on the same page—money can ruin relationships, even if the dollar amounts are small.
Avoid high-cost loans and predatory lenders, who will often dupe you into a loan you don’t qualify for or can’t afford. It’s tempting to take whatever you can get when you’ve been turned down repeatedly and don’t know how else to get a loan for the money you need. However, it’s not a good deal—they’ll lend you money, but you’ll find yourself in a hole that’s difficult or impossible to get out of.
Payday loans, which are high-interest short-term loans, tend to be the most expensive options. Likewise, loan sharks, who impose loan repayment terms that are virtually impossible to meet, can be outright dangerous.
There are other kinds of fast loans that can get you money quickly without the triple-digit APRs of payday loans, including payroll advances from your employer and Payday Alternative Loans (PALS) that let you borrow small amounts from credit unions. These lenders can be safer to deal with than storefront payday lenders.
Decide on a Bank Loan Amount
Remember that a loan isn’t free money—you will eventually have to pay the borrowed amount plus interest back to a bank or other lender. If you don’t make loan payments on time, your credit score could drop. This is why it’s important to settle on the right borrowing amount.
Consider the amount you need based on what you plan to do with the money. But also factor in what your regular loan payments might be and whether you can keep up with them according to the loan repayment period, be it monthly or quarterly.
It’s also a good idea to run preliminary loan calculations before settling on a loan amount. That allows you to see how much you’ll pay for a loan of a certain amount, and how a different loan amount (or loan term, or interest rate) might save you money. There are plenty of online tools out there to help you calculate loans. Of course, loan rates and lender terms can make your final loan installments slightly different.
If you have assets like equity in your home, you could potentially use your home equity as collateral to secure a loan ― this may allow you to take advantage of a higher credit limit, better terms, and a lower rate. But, remember, when you use an asset as collateral, the lender may have the right to repossess it if the loan is not paid back.
What it is
Capacity is an indicator of the probability that you’ll consistently be able to make payments on a new credit account. Lenders use different factors to determine your ability to repay, including reviewing your monthly income and comparing it to your financial obligations. This calculation is referred to as your debt-to-income (DTI) ratio, which is the percentage of your monthly income that goes toward expenses like rent, and loan or credit card payments.
Tips to keep in mind while applying for a personal loan
- First try the bank where you have a relationship, such as a salary account, home loan, car loan, etc, as the KYC process will be easier and faster.
- Compare personal loan interest rates, processing charges, the penalty for pre-payment/foreclosure, etc. All these charges will add up to your cost. A bank that offers a lower interest rate may charge a higher processing charge or penalty for foreclosure.
- Try to achieve and maintain a high credit score as that could improve the chances of your loan request getting approved. Remember, this is only one of the conditions for eligibility. The bank will evaluate it along with other conditions while reviewing your loan application.
- If you have other loans ensure the repayments are on time. This too could improve your chances of securing the loan.
How to Qualify for a Personal Loan
There is no one formula to qualifying for a personal loan—every applicant’s financial situation is different and unique. However, there are rules of thumb and recommendations that can help you improve your chances of qualifying for a personal loan.
Most personal loan lenders review your credit score, credit history, income and DTI ratio to determine your eligibility. While the minimum requirements for each of these factors vary for each lender, our recommendations include:
- Minimum credit score of 670. Maintaining a credit score of at least 670 will improve your chances of qualification. However, if you want to receive the most favorable terms, we recommend a minimum score of 720.
- Consistent and steady monthly income. Minimum income requirements may vary drastically between lenders, with some having no requirements. However, it’s crucial to have consistent and steady income at the minimum to demonstrate you can afford your monthly payments.
- DTI ratio less than 36%. While some lenders will approve a highly qualified applicant with a ratio up to 50%, it’s best to aim for a DTI that’s less than 36% to improve your chances of qualifying.
Because each lender has its own minimum requirements, it’s in your best interest to prequalify when possible and confirm with the lender what benchmarks you need to meet. This will ensure you only apply for loans that fit your specific financial situation.
Alternatives to bank loans
Bank loans are not your only option. You can work with alternative lenders to secure the funding you need. Alternative lenders are an option to consider if your business doesn’t qualify for a traditional loan. Here are two alternative lending options to consider:
- Online loans: Online lenders are normally more flexible with loan qualifications, and the turnaround time is faster, but the rates may be higher than traditional loans. Lendio is one such online lender. You can submit an application through their secure interface.
- Microloans: Microloans offer a small amount of money to help you cover certain costs within your company. Microloans usually have a relatively low interest rate. The disadvantages of microloans include a shorter time frame to pay back the loan, and some lenders require that the money from the microloan be spent on specific expenses like equipment purchases.
Tips for speeding up the process
If you’re looking for a personal loan, you likely want to get your hands on the money as soon as you can. These tips can help you avoid delays when applying for a personal loan”
- Check your credit report before applying. Know where your credit stands before shopping around for personal loans. Good credit can make it easier to qualify for a personal loan at a lower interest rate. Furthermore, spotting and correcting errors immediately is a simple way to avoid issues later on when you’re applying for a loan. Pay off debt. If you have debt and you don’t need the loan funds urgently, paying some debt off can raise your credit score and lower your DTI ratio, which can increase your chances of approval.
- Talk to your existing financial institution. Banks and credit unions might be more willing to consider a personal loan application from a customer with whom it’s had a positive, long-standing relationship.
- Get prequalified. Some lenders have a prequalification process that you can undergo without a hard credit check. You can also get an idea of what your loan rates and terms may be before you apply to determine if moving forward with the lender is worthwhile.
- Consider online lenders. Many online lenders offer next-day loan decisions, and funds may be deposited into your bank account within a few days after applying if you are approved.
- Pick loan funds up in person. If your lender has a brick-and-mortar location, ask if there is an option to pick funds up at the branch so you can get the money faster.
If you’re applying for a secured personal loan, your lender will require you to pledge valuable assets—or collateral. In the case of loans for homes or vehicles, the collateral is typically related to the underlying purpose of the loan. However, secured personal loans can also be collateralized by other valuable assets, including cash accounts, investment accounts, real estate and collectibles like coins or precious metals.
If you fall behind on your payments or default on your loan, the lender can repossess the collateral to recoup the remaining loan balance.
More about Personal Loans
A personal loan is a financial instrument that helps you avail funds for a multitude of uses. Like any regular loan; when opting for a Personal Loan you are advanced a specific amount of funds at a set interest rate and can clear it via a fixed repayment tenure. However, a few aspects of a personal loan may prove more advantageous than other loans lie such as: It does not lock in any of the applicant’s assets. As opposed to a Home or Car Loan which locks in the asset against which the loan is sought; Personal Loans provide advances for your needs without any collateral.Unrestricted usage: much like the name states. A personal loan is to be availed in case one needs a financial lump-sum for any personal use. Be it due to a medical/social event, lifestyle needs such as home repairs/renovation, or even to consolidate existing loans.
How to apply for a federal or private student loan
There are different application processes to follow, depending on which type of student loan you’re looking for.
The application process for a federal student loan
You apply for a federal student loan by filling out and submitting the Free Application for Federal Student Aid (FAFSA®). You MUST submit the FAFSA to be eligible for a federal student loan.
3. Know that loans can actually boost credit scores
If you are looking to take out a loan to consolidate credit card debt, or pay debt down faster, it can help in more ways than you may realize. Making payments in a reliable, timely manner will have a positive impact on your credit score as the lender reports these payments to the three major credit bureaus.
Paying down debt can also help improve your credit utilization ratio, which is the percentage of available credit you are using. Experts advise keeping this ratio at 30% or below.
Taking out a personal loan can actually help boost your credit score because your credit mix — which refers to the types of different credit accounts you have — determines 10% of your overall credit score.
Home equity line of credit Upgrades? This one’s on the house.
You’ve made the payments and added equity to your home—now it can help you build even more. Tap into your home’s equity to fix the roof, revamp your kitchen, or cover the patio. Treat yourself.
5. Make sure your bank offers personal loans
To get a personal loan from a bank, you’ll generally need to be an existing customer with good credit. Some banks don’t offer personal loans, so you’ll want to find out what your bank does offer.
If your bank doesn’t offer loans — or even if it does — you may want to get quotes from online lenders and credit unions. These options can be an alternative to bank loans, or a basis for comparison.
After you’ve checked rates offered by online lenders and credit unions, see if your bank will offer you a better deal.
A personal loan to pay off debt
Taking out a personal loan can also be a way to consolidate debt. This is the idea of putting all your debts together. If you have several different debts and find it hard to keep track of them, combining them into a personal loan can make it easier to focus on sending out just one payment.
You might also be able to get a lower interest rate if you consolidate debt with a personal loan. If you have credit card debt on a few different cards that have a high interest rate, you could get an installment loan to pay off the credit card debt. Instead of paying off several debts with high interest rates, you can work toward paying off one personal loan to pay less overall.
To get a deeper dive into how installment loans work, consider these two scenarios.
1. Using a personal loan to get back on track
Sue’s daughter recently broke her leg. While her daughter’s feeling much better, the incident left Sue with a few extra medical bills she wasn’t expecting.
For this reason, Sue is looking for help to get the medical bills paid. She decides to see if a personal loan might be the solution. After researching how to apply for a personal loan, Sue learns she can take one out through a bank or online lender.
Since she doesn’t need collateral for this type of loan, Sue feels comfortable taking out a loan for $5,000 with an 8% interest rate. By taking out a personal loan, Sue can be better able to handle this unexpected expense without it being a huge financial blow.
2. Using a personal loan to consolidate debt
Jack had very little savings when he started his food truck business. To pay for supplies, he used his credit cards. He now has balances of $5,000 on two cards, and one card with a balance of $10,000. That’s $20,000 of debt that needs to be paid off.
Jack researches his options and finds out he can get a $20,000 personal loan to pay off his debt. Jack’s credit cards have high interest rates, ranging from 10% to 20% on the balances. Instead of paying hundreds of dollars on interest, he can save by putting the amounts together in a personal loan to focus on paying off the lump sum of $20,000. And since his loan has an interest rate of just 8%, this lowers the amount he’ll pay overall on the debt.
The Bottom Line
A personal loan can be used for a variety of purposes, from debt consolidation to unexpected doctor bills to taking a vacation. Most personal loans do not require collateral, which makes them unsecured loans. This makes them easy to apply for.
Personal loans must be paid back over a set term, usually two to five years. The best personal loans will depend a lot on your creditworthiness (as measured by your credit score) and why you need the loan. Personal loans can be a fairly inexpensive way to borrow if you have good or excellent credit.