Personal loans are now the go-to financial tool for most Americans. About 22% of Americans have at least one personal loan, even though the demand for these loans slowed dramatically last year.
Personal loans grew faster than any other type of debt in 2019. That’s because personal loans allow you to use the funds for any purpose. Plus, you can get a nice-sized loan to help you gain financial footing.
Are personal loans always a good idea? There are a lot of advantages of personal loans, but there are cases when it’s a bad idea too.
You need to weigh your financial situation and make sure that you’re getting a personal loan for the right reasons. Skipping this step can cause more financial harm than good.
Do you want to know when it’s a good idea to get personal loans? Take a look at this guide that takes you through the reasons to get a personal loan and how to get one.
What Is a Good Reason to Get a Personal Loan?
There are risks of personal loans, so you need to make sure that you have a good reason to get a loan.
Let’s say that you want to start a business. A small personal loan gives you the capital you need to get your business off of the ground. These loans are much easier to get than business loans because you don’t have to present a formal business plan with your application.
The personal loan gives you room to start and grow your business. Once your business is off the ground, you can pay off the loan faster.
You Don’t Want to Use Credit Cards
Do you have a purchase that you want to finance, but you don’t want to use credit cards? That’s often a good idea because credit card interest is usually much higher than personal loans.
Credit card interest can be as high as 29% if you have fair credit. A personal loan might carry an interest rate of 10%. In that case, a personal loan is a much better option.
Finance a Large Purchase
Do you want to do a home renovation, but don’t want to refinance your mortgage? A personal loan gives you the funds for the renovation.
You can get a personal loan of up to $50,000, so you don’t have to put off that big project any longer. The best use of personal loans, for this reason, is to make sure your renovation delivers a return on investment.
There are some projects that won’t increase your home’s value at all. Those are the projects to stay away from. However, a project that increased your home value by 10% or more is well worth it.
Improve Your Credit History
For people with bad credit, a personal loan shows that you are able to handle credit. This is a smart move with a small loan of $1,000 or less.
You have a bad credit score, so you’re going to face very high interest rates. A personal loan will improve your credit score over time as long as you pay the loan back on time.
Are personal loans bad for credit? When you apply for personal loans, lenders will do a hard check on your credit score. A credit inquiry will drop your credit score by a few points.
If you apply for credit cards and loans at the same time, it’s a sign that you are in financial trouble. Lenders see that as a red flag and won’t approve your loan.
What you can do is get pre-qualified for a personal loan, which only requires a soft credit check. A soft credit check won’t show up on your credit report. It does give you enough information to compare loans.
Personal loans are bad for your credit score when you fail to pay the loan back on time. This is a significant hit on your credit report that stays with you for years.
Credit Card Consolidation
You learned earlier that personal loans tend to have lower interest rates. If you’re in a situation where you have a good amount of credit card debt, a personal loan can help you.
You can pay off your credit cards with the loan. You’ll have one monthly payment with a lower interest rate. You need to make sure you don’t run up your credit cards once they’re paid off.
Reasons to Avoid Personal Loans
Are there reasons to avoid personal loans? If you’re planning to use a personal loan for a vacation or a frivolous purchase, skip the loan.
You’ll want to save up money for these purchases, as opposed to using a personal loan.
Another reason to avoid getting a personal loan is if you’re using it to pay your bills. You’ll want to assess your spending and income. There are other ways to make ends meet, such as cutting expenses or getting a part-time gig.
How to Get a Personal Loan
Do you feel that you have a good reason to get a personal loan? It’s time to find out how to get one.
Start with learning about the different types of personal loans. There are two categories: secured personal loans and unsecured personal loans.
A secured personal loan is guaranteed by some kind of collateral. You’ll see this often for larger personal loans and for those with bad credit.
The loan is secured by some kind of property, such as a home or a vehicle. If you fail to pay the loan back, the lender can seize the assets used as security.
An unsecured loan has no such clause in the loan agreement. You get the funds without collateral. If you fail to make payments, your credit score will decrease.
There are other types of loans, but they have to do with the interest rate. A fixed-rate personal loan means that the interest rate you have now is the rate for the life of the loan.
An adjustable-rate loan means that the interest rate will adjust periodically. Banks may do this annually or quarterly. This is a bad idea when interest rates are at record lows.
You know that the interest rate will increase eventually. That leaves you with a larger monthly payment.
Have a Budget
Review your budget before getting a personal loan. You want to make sure that you get a loan that you can afford to pay back.
Take a close look at your income and expenses. Make any adjustments to make room for the monthly payments.
You can find lenders all over the place. You can go to your bank or find lenders online. Be sure to look at the loan beyond the interest rate and the monthly payment.
Review the total cost of the loan, the terms of the loan, and any administrative fees. Lenders are happy to add on fees, so make sure your lender is transparent.
Remember to get pre-qualified first to compare the loans. Once you settle on one lender, fill out the application and have them do a hard credit check. That minimizes the impact on your credit score.
Gather Your Documentation
Lenders will want to see documentation along with your application. They’ll want to see your latest paystubs and W-2 forms.
They want to confirm that you make enough to pay the loan back. They may also request your latest tax return and bank statements.
Have these documents ready to go to speed up the application process.
Tips to Clean Up Your Credit Report
You may have a mediocre credit score. Your chances for approval are lower and chances for a high interest rate are higher.
There are a few things you can do to clean up your credit score. The first is to get your credit report for free from Annual Credit Report.
Make sure that your information is correct. If there is something that’s wrong, get it corrected as soon as possible.
Look for opportunities to clean up your credit report quickly. The credit utilization rate often has the largest impact on your credit score. Get your credit card balances down and see your score rise quickly.
Otherwise, you have to make regular payments over a long period of time to bring your score up.
The Top Reasons to Get Personal Loans
There’s no question that personal loans are popular because they give you the financial flexibility to accomplish so much. You can do anything from start a business to pay off old credit card debts.
The risks of personal loans often outweigh the benefits, so you need to make sure you’re getting the loan for the right reasons.
Be sure to take your time to compare lenders and clean up your credit report before getting a personal loan. You’ll end up in a better financial position with a higher credit score.
For more financial tips, check out the other articles on the blog today!
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