Have you received a loan offer in the mail recently? Or, maybe you’ve been thinking about ways to meet pressing financial needs. No matter what those needs are, a personal loan can seem like a quick path to a sense of financial relief.
But, while a personal loan presents you with a potential financial reward, there are also some risks. In this article, you’ll find money expert Clark Howard’s thoughts on personal loans and answers to commonly asked questions, including:
- What Is a Personal Loan?
- Clark Howard’s Thoughts on Personal Loans
- How Do I Get a Personal Loan?
- Where Can I Get a Personal Loan?
- What Is the Interest Rate on a Personal Loan?
- What Are the Pros and Cons of a Personal Loan?
What Is a Personal Loan?
A personal loan is money that you borrow — whether from a bank, credit union, or other lender — which can be used to meet your financial needs. A few ways people commonly use personal loans include: to pay off high-interest credit card debt, to cover the costs of unexpected home repairs or health care, or to finance larger purchases.
How Does a Personal Loan Work?
Personal loans are appealing because they’re typically short-term, with repayment periods running between two to seven years. And generally, personal loans have fixed monthly payments and fixed interest rates. So, you go into the loan knowing how long it’ll take and how much it’ll cost to pay back the borrowed money.
The majority of personal loans fall into the category of unsecured debt, which simply means you don’t have to put up any collateral to be approved. With unsecured debt, there are no assets that creditors can seize or repossess if you fall behind or stop making payments. There are other actions lenders can take to make unsecured debt less risky though. For example, lenders can report you to credit rating agencies and ruin your credit. And in some instances, lenders might sue to attempt to collect any losses.
Clark Howard’s Thoughts on Personal Loans
A personal loan may once have provided a great opportunity to get out from under high-interest debt, but times have changed and so has the market.
“It used to be there were a lot more, you know, there were the peer-to-peer loans that were available from Prosper and LendingClub,” says Clark. “They’re a much smaller player than they used to be. So, you may be finding good availability — good personal loans — to replace credit card debt…[but] I don’t know that they’re as available as they were even, let’s say, three years ago.”
Where a personal loan could once be considered a great opportunity to help you get out of high-interest debt, it’s now just potentially a good one. There are benefits and risks. Keep reading for some of Clark’s thoughts on what’s what when it comes to personal loans.
Benefits of Personal Loans vs. High-Interest Credit Card Debt
There are two key benefits that Clark says personal loans offer. The first benefit is a fixed interest rate.
“Where credit cards have variable rates, personal loans often are fixed rates,” says Clark. “And that’s a definite advantage, to not have to worry that interest rates are going to go up at any time, unlike on a credit card since they’re revolving.”
Revolving credit refers to a credit line that is essentially open-ended: Once you pay back a borrowed amount, those funds become available for you to borrow again. But personal loans are a type of installment credit. This means you get a lump sum of money and a schedule to repay it all off by a predetermined date, which is a good thing.
“Another benefit of a personal loan is that you’re taking it out usually for a set term,” Clark explains. He adds:
“If you feel like you’re going to be in credit card debt for the rest of your life: If you go into a loan that’s for a set number of months and you live up to its terms and conditions, you’ll wipe that debt out when you hit the end of those months.”
That said, there are a few things Clark wants you to look out for if you’re taking a personal loan.
Things To Watch Out for With Personal Loans
“With any personal loan, I’m always concerned about application fees, origination fees, or early termination fees. In addition, you have to pay really close attention to the interest rates,” he says.
Some lenders may require borrowers to pay various fees to help make up for the costs of the process of getting a loan. An application fee is a cost you’re charged to apply for a loan. So, even if you’re denied, there’s a chance this fee is non-refundable.
Loan origination fees can include application fees, but sometimes loan origination fees are charges for other parts of the borrowing process. For example, a lender might tell you that their loan origination fees are for admin, application and/or underwriting costs. And — unfortunately — some lenders charge early termination fees, or penalties if you pay your loan off ahead of schedule. Early termination fees can also be called prepayment penalties.
Another thing Clark wants you to pay attention to is who or what organization you’re considering borrowing money from. If, for example, you find what seems like a great offer from a company you’ve never heard of, be sure to do your research before signing on! And also look out for what interest rates they’re offering you. Clark says:
How Do I Get a Personal Loan?
If you’ve decided that a personal loan is right for you, then we’ve got five steps to help you shop around for one that meets your needs. When you’re ready, here’s how you can get a loan:
1. Review your credit.
First, take a look at your credit report and credit score. Your credit report is a detailed statement that shows your credit history and activity, like any open accounts, their limits and balances, and your payment history. Meanwhile, your credit score is a three-digit number that quickly showcases your credit “worthiness,” or reliability, to lenders or other businesses.
Checking your credit report and credit score is easy. We’ve got a guide on how to get a free credit report. And check our article that shares a few ways to get your credit score for free.
You’ll also want to make sure your credit isn’t frozen before applying for a personal loan. Whether you’re not sure what that means or you want to know how to unfreeze (or freeze) your credit, here’s another guide to review: How To Freeze or Unfreeze Your Credit.
2. Calculate your debt-to-income ratio.
Your debt-to-income (DTI) ratio shows the relationship between how much money you make and how much money you owe in any given month. Lenders use your DTI ratio to assess how risky you are as a borrower.
The wider the gap between what you make and what you owe, the less risky you are. On the flip side, however, if what you owe each month is close to the number of your monthly earnings, then lending you money is riskier.
To calculate your DTI ratio: Divide all your monthly debts — think credit card bills, utilities, student loans, and any other monthly obligations — by your gross monthly income. Your gross monthly income is what you make before taxes or other deductions are removed. Here’s the formula:
| Calculate Your Debt-to-Income Ratio |
| Total Monthly Debts / Gross Monthly Income = Debt-to-Income Ratio |
Using this formula will show your debt-to-income ratio as a decimal. To see it as a percentage, simply multiply the decimal by 100. Here’s an example: $1,500 total monthly debts / $4,200 gross monthly income = 0.357 debt-to-income ratio. Multiply 0.357 debt-to-income ratio by 100 (0.357 x 100), and you see the DTI is 35.7%, or approximately 36%.
When applying for a personal loan, Experian says, “You’ll typically need a DTI of 35% to 40% or less, although you may qualify with a higher DTI if your credit is strong.”
For people with a high DTI and/or credit scores on the lower end, a co-signer might be necessary to get a personal loan. If that’s you, it’ll be helpful to have someone in mind before you move to the next step.
3. Get quotes from lenders.
Now, you’re ready to research lenders and begin getting quotes or pre-qualifying. As you start your search, look into what a lender requires and offers before you apply. This will save you time during your application process.
For example, you don’t want to apply with a company that doesn’t offer the loan amount you’re looking to get. Or, if your credit score doesn’t meet a company’s minimum requirements, then you should skip applying there too.
Additionally, if you need your funds quickly, find out what each lender’s funding time is for a loan. And of course, it’s important to pay attention to the available repayment terms and annual percentage rates (APRs) for each lender.
A repayment term is how long you have to repay the loan. And the APR includes a loan’s interest rate and any other fees for the loan. Basically, the APR shows you the actual cost of the loan.
Once you’ve researched lenders, start getting quotes. Pre-qualifying for a loan usually requires lenders to run a soft inquiry on your credit, which won’t affect your credit score. But you might need to apply to get the full picture of what a lender is offering.
Just know that an actual application will count as a hard inquiry on your credit. So here’s a tip: When you apply to lenders, do it all at once. This minimizes the impact of hard inquiries on your credit report, which may lower your score for up to two years.
Not sure how many lenders you should get quotes from? Clark says:
4. Choose a lender.
After you’ve gotten quotes from five lenders, it’s time to choose the best personal loan for you. To do this, read all the available fine print from each lender you’re considering. Then, compare their offerings against each other. It’s especially important to pay attention to the APR of each loan. Usually, the lower the loan’s APR, the less you’ll ultimately pay it.
Once you’ve compared the offerings from each lender, choose the one that best meets your financial needs and goals (ex: loan amount, APR, repayment term, etc.). If you’ve only pre-qualified for their loan at this point, you can now complete an application.
After you apply, you’ll need to wait for the lender’s decision. Depending on the lender, you might be waiting for just a few minutes or up to several days.
5. Complete the loan agreement.
So, you’ve applied and been approved for a personal loan? The final step in getting your funds is completing the loan agreement. This is the time for you to carefully read through all the fine print of the loan before you sign.
Remember: Clark wants you to look out for any fees — like application, origination, or early termination fees — the lender might add to your loan. Keep an eye out for repayment terms as well. You need to know how your lender expects to be paid, especially if they require bank account details to set up automatic payments.
Once all your paperwork has been completed, you can expect to receive funds within the window stated as the funding time on your agreement. Again, depending on your lender, this could be within a few hours or up to several days.
But what if your application is denied? The Fair Credit Reporting Act (FCRA) requires the lender to send you an adverse action notice, or letter. This letter explains why you were denied and can help you know what can be changed or improved on your end before applying for another personal loan. According to the Consumer Financial Protection Bureau:
- You must be told if information in your file — including your credit report or any other consumer report — has been used against you.
- You have the right to know what is in your file.
- You have the right to dispute incomplete or inaccurate information.
You can read the full summary of your rights under the Fair Credit Reporting Act here.
Where Can I Get a Personal Loan?
There are lots of different types of places you can go to for a personal loan. Let’s take a look at some of the options.
Banks
Not every bank offers personal loans, but many — from the small local banks to well-known national ones — do. And unlike with credit unions, you don’t need to be a member to qualify. But members are more likely to get lower rates and more money than non-members.
Banks can be a good place for personal loans if you want in-person support. But you’ll likely need higher credit to qualify and you might not be able to get the lowest rates when comparing with credit unions or online lenders.
Credit Unions
Are you a member of a credit union? If not, it might be time to join one. Credit unions are a great place to start when looking for a personal loan. And Clark happens to be a fan. He says:
Credit unions tend to have lower APRs on personal loans than other types of lenders. And they’re known for offering their members more flexibility when it comes to approving people who don’t have stellar credit scores or reports. But, if you’re looking for a more substantial loan, a credit union might not be able to meet the amount you’re hoping to get.
FinTech Companies
According to the U.S. Government Accountability Office (GAO), FinTech — or financial technology — lenders are, “nonbank firms that operate online and may use ‘alternative data,’ including rental property or utility payments, to help determine borrowers’ creditworthiness.”
The GAO says that Fintech lenders may be beneficial for people, “whose traditional credit history may have been insufficient to extend them credit. But, there’s also concern around a lack of clarity of what “alternative data” is and how it’s used in credit decisions.
If you’re less familiar with FinTech companies than other types of lenders, SoFi are Avant are two of the largest ones offering personal loans.
Peer-to-Peer Lenders
A peer-to-peer (P2P) loan is when a borrower gets money from another person (or group of people). It works like this: Instead of relying on a bank, credit union or other institution for funds, money is borrowed directly from an individual investor or group of investors.
That said, most peer-to-peer lenders use companies to facilitate loans. Consider Prosper, a company that describes itself as “the first peer-to-peer lending marketplace in the United States.” The company allows borrowers and investors to engage in an online marketplace. Borrowers request their desired loans. And investors can participate in “hands-off or hands-on” investing, by auto-investing or personally selecting loans to fund.
If your credit score isn’t high enough to qualify for funds from a bank, you might qualify for a peer-to-peer loan. But you’ll also likely have a higher interest rate. Also, P2P lenders are known for tacking on additional fees.
What Is the Interest Rate on a Personal Loan?
One question that borrowers often wonder when considering a personal loan is: am I getting a good interest rate? The answer: It depends.
Interest rates on personal loans can vary greatly from person to person. Your credit plays a huge role in just how good of an interest rate you can get. The better your credit is, the better your interest rate will be.
But Experian defines a “good interest rate” as such:
“A good interest rate on a personal loan can depend on current economic conditions, but it’s generally a rate that’s below the current national average.”
According to Investopedia, the average personal loan interest rate is currently around 23.63%. In general, however, interest rates can start as low as around 6% and can soar past 295% in extreme cases! Investopedia reports that they gathered data from 118,000 quotes across 18 lenders in January 2024. Based on this data, here’s the average APR on personal loans based on credit score tiers:
| Credit Tier | Average Personal Loan APR (Jan. 2024) |
| Excellent | 20.17% |
| Good | 24.05% |
| Fair | 30.57% |
| Poor | 31.52% |
| All Tiers | 23.63% |
While Investopedia only includes four credit score ranges, it’s more common to see five ranges. Companies like Equifax and Experian define credit tiers as follows:
- Excellent: 800-850
- Very good: 740-799
- Good: 670-739
- Fair: 580-660
- Poor: 300-579
TransUnion has a slightly different categorization for credit tiers. But you can use these ranges as a guide to guesstimate where you fall and get an idea of what to expect when applying for personal loans. But your credit score isn’t the end-all-be-all when it comes to interest rates.
Other Factors That Influence Your Interest Rate
In addition to your credit score, the current market conditions, your lender, and the length of your repayment term impact your APR. We can’t control how the Federal Reserve raises its interest rates or how lenders weigh the criteria they use for assessing borrowing riskiness.
But repayment terms are something you can have a say in. As a general rule, it’s better to have a shorter loan term than a longer one for personal loans. Why? Let’s consider a 60-month term and a 36-month term. The monthly payment will be lower on the 60-month term, but you’ll end up paying almost double in interest and fees over the life of the loan during the longer term.
Additional factors that you can directly influence, which will impact your interest rate include your loan amount, credit report, and debt-to-income ratio.
What Are the Pros and Cons of a Personal Loan?
Personal loans can be used for just about anything. But they shouldn’t be. For example, it might make sense to get a personal loan when you’re caught up in high-interest debt. But it’s not advisable to take a personal to fund a family vacation.
Pros of a Personal Loan
The best-use scenario for taking a personal loan is when it will help provide financial relief from high-interest credit card debt. Credit card interest rates can change with time, which can slow down your pay-off progress. But personal loans typically have fixed interest rates, which is a major pro in this situation.
Additionally, personal loans have repayment terms. So, when it’s time to pay down your balance, you see the light at the end of the tunnel from the very beginning. As long as you make your payments as scheduled, you know exactly when your debt will clear.
Cons of a Personal Loan
If you’re on top of a mountain of high-interest credit card debt, it’s important to understand how you got there. Life happens. And sometimes a credit card might be your only option to escape the devastation of an unexpected expense.
But if you’re working on paying off debts, it can also be helpful to find resources and start putting tools in place to build up your savings for the future. You might find there are spending patterns that need to be addressed. There’s a very real risk that if you take out a personal loan to pay off high-interest debt — without changing spending behaviors — you’ll find yourself deeper in debt down the line.
Alternative to a Personal Loan
To pay down high-interest debts, you might be better off securing a 0% APR balance transfer offer instead of getting a personal loan. These offers allow you to transfer existing debts to a new credit card that has an introductory rate of 0% APR for a set period of time.
But, of course, there’s a catch. The 0% APR doesn’t last forever. So, before you do this, you need to determine if you can reasonably pay off your debts within the time frame of the introductory offer. Or, you should be sure that once that offer expires, the card will still be beneficial towards meeting your goals. Otherwise, you could end up with higher interest rates than you were paying to begin with.
Final Thoughts
Personal loans can be tempting and make sense in some financial situations, but there are always risks to increasing or moving around debt. Before you take a personal loan, assess your circumstances. Take stock of the factors that have you considering a personal loan and see if there are any habits that should be addressed.
In general, it’s better to try and set your own budget so that you can come up with extra money to pay off your existing debt on your own before taking on a personal loan. But, in more extreme circumstances, a personal loan might be the right move to kickstart your financial relief.
