If you’re working toward a personal financial goal, such as paying off debt or making home renovations to increase your house’s value, securing a personal loan to pay for these expenses can be a good idea. Outside of achieving financial targets, life happens, and sometimes you need some extra cash to pay for emergency expenses or make a big purchase.
Whatever the case, here’s why personal loans may be the best choice for you.
What is a Personal Loan?
Unlike auto loans or home equity loans, a personal loan is a form of credit that can be used for a variety of purposes. Personal loans can be leveraged to help you consolidate debt—especially higher-interest debt—such as credit card debt or student loans. They can also help you pay for medical expenses and other unanticipated costs or purchase significant items such as new home appliances.
A personal loan is typically an unsecured loan, which means there’s no collateral involved. Instead, the installment loan is backed by your credit, which is why it’s beneficial to have good credit when applying for a personal loan. However, some lenders may offer secured personal loans, which could potentially provide better rates.
When you secure a personal loan from a credit union, you are more likely to find better rates and more flexible terms than you would with a bank or other financial institution. The initial amount you borrow, or principal, will decrease with every payment you make. However, like most financing options, you will be required to pay interest—the lender’s fee for allowing you to borrow the money.
How Do You Get a Personal Loan?
To find out if you qualify for a personal loan, lenders will likely check your credit score, payment history, and income.
Credit Score
Your credit score is the most important indicator of your creditworthiness when determining your loan eligibility. So if you have bad credit, it’s not likely you’ll be able to get a loan with a reasonable interest rate. In this case, you may need to wait until you can improve your credit situation or find a cosigner with good credit, which will enhance your eligibility for loans with better interest rates.
This will require a hard credit pull when you apply for a personal loan, which may initially affect your credit score.
Payment history
Your payment history is a determining factor of your credit score, making up 35% of your FICO score. If you have a history of missing payments, even just one late payment will remain on your credit report for up to seven years. The better your record of making payments on-time, the more likely you will get approved for a personal loan with a better rate and term, and the better off your credit score will be.
Income
Once lenders have determined that your credit is in good standing and you have a strong payment history, you can expect them to check your income to ensure you have adequate money to put toward your loan payments. The lender will want to see that you have a low debt-to-income ratio, or DTI, which is a good indicator of how much you spend versus how much you make. The lower your DTI, the more favorably lenders will look upon your application since it shows less risk of defaulting on the loan.
To calculate your DTI, simply add up your minimum monthly debt payments and divide them by your gross income.
How Personal Loans Differ From Other Financing Options
Personal loans, credit cards, and payday loans are all go-to options to get cash in a pinch. However, here’s how personal loans are different, and in most cases, more beneficial than other forms of quick financing.
A personal loan differs from a credit card in that a credit card is a type of revolving credit that the borrower can access as long as their account is in good standing. With a personal loan, the borrower gets a lump sum upfront to make fixed payments each month until the full loan amount is paid off. In most cases, credit cards have higher interest rates than personal loans, which is what makes personal loans an attractive option for many people.
Similarly, personal loans vary from payday loans, primarily concerning the terms and conditions. Personal loans typically allow you to borrow amounts that range anywhere from $1,000 to $50,000 with relatively low interest. In contrast, payday loans offer much smaller loan amounts, usually around $500 or less, and have much higher interest. If you need to finance a significant expense, a payday loan likely won’t be a suitable option.
What Can Personal Loans Be Used For?
When you don’t have enough savings to afford what you want or need, there are a few situations where using a personal loan may be the best choice for you.
Debt Consolidation
For instance, personal loans are an excellent financing choice for debt consolidation, such as paying off the balances of multiple credit cards by combining them into a single, more affordable monthly payment. This strategy can help you secure a lower interest rate than what you currently pay on your credit cards and give you more manageable payments in the long run. If your goal is to pay off debt, debt consolidation with a personal loan is an excellent choice.
Home Improvements
When you’re considering making home improvements to add value to your home, a personal loan can help you afford them. This is a popular alternative to a home equity loan, which requires that you use your home’s equity as collateral. The advantages of a personal loan include a faster approval process and less paperwork. Additionally, you don’t have to worry about declining home value or your home being at stake.
Financing Big Purchases or Events
If you need to make a big purchase and were already planning to take out a loan, using a personal loan to pay the seller in cash is usually a better deal than using a high-interest credit card or financing through the seller. The same applies to big events like weddings or vacations, where you can save on interest and pay off the event over an extended period.
Why Personal Loans are Preferable
When it comes to consolidating debt or financing home improvements or other big purchases, personal loans are preferable for their lower interest rates and set payments.
If you are diligent about making on-time payments, personal loans can even help you boost your credit score by adding to your credit mix. To help you stay on top of your payments, many lenders offer mobile apps that enable you to track your loan and schedule payments, so you never miss one. Some even provide flexible payment schedules that allow you to defer payments or change due dates.
Some personal loans may offer additional benefits such as free credit monitoring and other financial literacy resources that can help you improve your credit score and make smart fiscal decisions.
The Takeaway
While using savings is always the preferred way of paying for big purchases and other needs, sometimes draining your savings account just isn’t an option, or you may not have enough savings on hand. In the event you need to borrow money, securing a personal loan may be the best choice.
If you need help consolidating debt or financing other big expenses, apply for a personal loan today with T&I Credit Union by calling (248) 397-9571.
