It’s no wonder debt gets a bad rap. More than 80 percent of Americans have unwanted debt.
But this doesn’t mean debt should be avoided in all situations. Whether or not to take out a loan, depends heavily on your personal circumstances.
There are plenty of situations where debt is the best possible option for you. Here are the top benefits of personal loans to consider when you’re in a financial pinch.
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What is a Personal Loan?
A personal loan is a loan taken out for general purposes. Unlike a mortgage or car loan, a personal loan can pretty much be used for anything you need.
There are restrictions on using personal loans on things like higher education tuition or certain business needs, but you can usually use the funds for whatever you need once the money hits your account. There are a variety of lenders that offer personal loans.
Credit unions, banks and private lenders are available for personal loans as long as you’re creditworthy. Typically, personal loans are only available to people with good to excellent credit ratings.
You need good credit for personal loans because this type of debt usually comes at very competitive interest rates. Lenders want assurance that borrowers have a strong financial history before they’re approved.
Borrowing a personal loan is very different from spending money on a credit card. You are responsible for making uniform payments over a certain amount of time until the debt is fully repaid.
This means you don’t have to worry about surprise fees or finance charges unless you pay late or miss a payment. Here are a few aspects to personal loans you’ll want to know before applying.
Principal
The amount you request to borrow on a personal loan is called the principal. For example, if you’re taking out a $20,000 loan, the principal includes only the $20,000.
You interest charges are based on the $20,000 The more you repay on the loan, the more your principal balance decreases.
Interest
The interest on your loan is a legal requirement of taking out the debt. The interest rate is how the lender makes a profit.
Think of your interest rate as the fee required to use someone else’s money for your needs. The interest charges makes your monthly charges higher than if you were simply repaying the principal balance.
Interest rates are always shown as a percentage.
Annual Percentage Rate
Your Annual Percentage Rate, or APR, is added to your loan in addition to the interest. Lenders charge APR fees to cover the cost of managing your loan.
Combining the lender’s fees with your interest rate usually gives you your anticipated APR. When comparing loans, look at the APRs of each product instead of looking at the interest rates.
Unsecured Debt
When you purchase a home, you’re not technically the homeowner until the debt is paid. The lender uses your new home as collateral to secure the debt until the end of the mortgage term.
Collateral is anything the lender can take possession of if the loan balance goes unpaid. Personal loans are unsecured.
This means you don’t have to worry about losing your house or your car if you fall behind on payments. Unsecured debts are risky for lenders.
You’ll have a hard time getting approved for a personal loan if you have few assets, bad credit and inconsistent income. The amount you can borrow is usually based on your income.
Lenders want to confirm that in a pinch, you’re earning enough to cover your debt payments over the long term.
Lower Interest Rates
One of the biggest benefits of personal loans is low interest rates. Personal loans allow you to borrow more money cheaper than you could using a credit card.
You also have a firm monthly installment amount that won’t go up or down depending on how you’ve used the loan. With credit cards, your interest rate might be higher on things like cash advances or when traveling abroad.
You can use your personal loan for any transaction without worry over fluctuating monthly payments. A low interest rate can make or break a monthly payment amount.
High interest rates can make even small loans unaffordable to repay. When you repay your personal loan, the first part of your term is repaying interest.
This allows lenders to get their money in advance. You’ll pay longer on your loan or make higher payments if the interest rate is high.
Fast Funding
Personal loans are usually financed within days. There are some banks and online lenders that offer same day funding depending on how your application is submitted.
This is one of the benefits of personal loans that people consider in an emergency. A personal loan might be the only solution when you need money within a few days.
Credit cards can take weeks to arrive in the mail. If you need to get out of a bind fast, apply for a personal loan.
Keep in mind that all personal loans aren’t created equal. Payday loans have much steeper fees than a traditional lender.
Aim for lenders that can offer you the best terms first. You can quickly spiral into a debt trap if you choose a lender with unmanageable payments.
Start online with a lender like Plenti to compare loan terms before making a final commitment.
Flexible Terms
Another benefit of getting a personal loan is the option to choose your terms. Depending on your lender, you’ll usually have at least two options for repaying your loan.
Your interest rate is dependent on the terms you choose. For example, shorter repayment periods mean lower interest rates. This is because shorter repayment periods are less risky for lenders.
The sooner you repay the debt, the lesser the chances you’ll default on your loan agreement. Choosing longer loan terms lowers your monthly payment but increases your interest rate.
Personal loans give you the option to be in control of your monthly installment payment before making a commitment.
Building Credit
Obtaining a personal loan is a great way to improve your credit rating. Perhaps you’re in limbo with all your debt because you don’t use credit cards and your car is paid off.
Though your credit score could still increase with monthly mortgage payments, it will be a long, slow process. Give your credit a boost with a personal loan.
Not all types of personal loans report to the three major credit bureaus. Payday loans won’t report your on-time payments.
Stick to a private lender or bank to ensure you’re getting credit for being in good standing with your lender. Your score increases with each on time payment.
The longer you repay the debt, the more your score improves with time. There are five factors to consider when looking to use personal loans to boost credit scores.
On Time Payments
The biggest factor when using personal loans as a credit boost is whether you can make on time payments. On time payments account for around 35 percent of your credit score.
If the monthly payment amount seems unaffordable, consider declining the loan or requesting a longer repayment period. Setup automatic payments so you don’t forget each month. You want on time payments to be your number one priority during your loan term.
Amount of Credit Available
Since a personal loan doesn’t replenish, the amount of credit available won’t affect your score much. Just make sure you’re not borrowing more than you need so your debt to income ratio doesn’t seem overly high.
Length of Credit History
The length of time you’ve owned credit accounts helps your score. This means keeping open accounts while you repay your debt is helpful.
Avoid closing any accounts or credit cards even if you rarely use them.
New Inquiries
Apply for all personal loans within a 30 day period. Too many new credit inquiries can lower your score.
There’s typically no penalty for shopping around for a loan for a single purpose. For example, when shopping for a mortgage, multiple inquiries from mortgage lenders won’t lower your score.
Type of Credit
The type of credit you have impacts your score. A personal loan is a type of good debt.
Unlike owning credit cards, you only access funds once which lowers your chances of ending up with more debt than you can afford.
Benefits of Personal Loans
There are few debt options that offer the peace of mind you can have with a personal loan. Getting a personal loan can instantly solve a financial crisis in a way that’s affordable and flexible.
You can use other people’s money to fix just about any issue that arises in your personal life. Make sure your loan term makes sense if you want your credit score to improve during the life of the loan.
Remember that not all types of personal loans are created equal. Avoid doing business with shady lenders as your loan terms could fluctuate when you’re not paying attention. For more information and tips, visit our blog for updates.
