What is a personal loan?
When you take out a loan from a bank, credit union or online lender, it is called a personal loan. Typically, personal loans are distributed in a lump sum and repaid in monthly installments.
Certain types of loans are used to pay for specific purchases such as a home or a vehicle. But the best unsecured personal loans can be used for almost any reason. For example, you can take out a personal loan to pay for emergency home repairs, finance home renovations, pay for a wedding, or cover medical expenses. With an unsecured personal loan, the lender requires nothing more than your good credit and your written promise to repay the loan as agreed.
In exchange for using the money from the lender, you repay the loan with interest. The higher your credit score, the lower the interest rate you can expect from the lender. Even if your credit score is not as high as you would like, you may still qualify for a personal loan with bad credit. However, you will likely pay a higher interest rate than other borrowers.
When is a personal loan a good option?
Let’s say your kitchen was designed under the Truman administration or you want to consolidate your debt. A personal loan can provide you with the funds to get things done. Most lenders don’t care how you spend the money, as long as you pay it back as promised. If you know how you’re going to spend the money and have a plan for paying it back, a personal loan can be a great tool for achieving your goals.
If you need your personal loan money fast, look for a loan with “simplified approval”. This means you won’t have to wait long to receive the loan funds. Since some loans are funded the same day, if you run into a financial roadblock, a personal loan can help you overcome it, even when you need money fast.
What should I look for in a personal loan?
You may be surprised to learn how many loan options there are. Whether you have great credit or are looking to improve your credit score, the best loans on the market have these three things in common:
Low interest rate
A good loan is one that carries a low interest rate. Interest on a loan is calculated as a percentage of the total you borrow. The lower the interest rate, the more money you save by repaying the loan.
Let’s say you need to borrow $20,000 to replace the roof on your house and you’re considering getting a five-year loan. You are considering two options: lender A and lender B. Below we have summarized these two imaginary lenders and the impact of their interest rates on the cost of your loan. Even a small percentage change can result in significant savings. Clearly, the lender offering the lowest interest rate can save you money over the life of the loan. These are funds that you can use in other ways, such as investing for your future.
- Interest rate: 5.5%
- Monthly payment: $382
- Total interest paid over the life of the loan: $2,921
- Interest rate: 6.9%
- Monthly payment: $395
- Total interest paid over the life of the loan: $3,705
You can only pay $13 more per month for a loan from Lender B, but that small difference is costing you $780 more over the life of the loan. To help you find the best low interest loans, check out our guide to good interest rates for personal loans.
Do you have bad credit? You will likely pay a higher interest rate for a personal loan. If this is your situation, you have two options. You can take steps to increase your score and wait until it is in better shape before applying for a loan. The second option is to get a loan now and then refinance your personal loan later (when your credit score is higher and you can get a better rate).
Loan terms that suit you
The “loan term” is the amount of time you have to repay a loan in full. Some people opt for a longer loan term because it lowers their monthly payments. However, the longer you carry a loan, the more interest you pay in total. Find the sweet spot for your personal loan, the shortest term with the most affordable payment. The best loans fit your budget and your time frame.
Another key feature of a good personal loan is that it has no fees or very low fees. Fees can be sneaky. Suppose a lender offers you a low interest rate, but racks up the fees. This loan may end up costing more than a loan with a slightly higher interest rate but no fees. The best personal lenders don’t charge origination fees and keep other expenses, such as prepayments and late fees, to a minimum.
For example, many lenders charge origination fees to cover the costs of processing and distributing your loan. Origination fees vary from 1% to 8% of the amount you borrow. Using the scenario above, if you borrow $20,000 to replace a roof, you could pay between $200 and $1,600 in assembly costs alone.