Have you seen an influx of personal loan offers showing up in your mailbox? These unsecured loans promise access to capital to help you pay off high-interest credit card debt, make improvements to your home and more.
But in reality, there’s both hazard and opportunity here for potential borrowers. The key is knowing which is which, according to money expert Clark Howard.
Here’s What You Need to Know About Personal Loans
The market for personal loans is a growing one. Everyone from big Wall Street firms like Goldman Sachs and American Express to smaller fintech lenders like SoFi and Lending Club want a piece of this market.
No wonder, then, that there’s nearly $160 billion in outstanding balances on personal loans, according to analysis from LendingTree.com. Meanwhile, some 20 million consumers now have at least one of these loans.
“If you have high-interest debt, this is a great opportunity for you to get out from under it,” Clark says of personal loans in general.
Yet the idea of personal loans isn’t all roses for consumers. For instance, those who take them out will most likely see their credit scores drop under a new credit scoring model being introduced this summer.
So before you sign on the dotted line, here’s what you need to know…
Table of Contents
- What Is a Personal Loan?
- How Do I Get a Personal Loan?
- Where Should I Apply for a Personal Loan?
- What Is the Interest Rate on a Personal Loan?
- What Are the Benefits of Obtaining a Personal Loan?
- Are There Dangers to Getting a Personal Loan?
What Is a Personal Loan?
Where Should I Apply for a Personal Loan?
When you’re ready to apply for a personal loan, you should aim to get quotes from five different places. There are some websites that will act as aggregators to serve up multiple quotes at once.
“The typical person will only apply three places,” Clark says. “By looking at five, you’re likely to find a better interest rate.”
Some options you might look at include:
- Fin-tech companies like Marcus and SoFi
- Peer-to-peer lenders like Prosper
- Online banks like Discover
- Smaller local credit unions
Clark is a big fan of looking at credit unions in particular. “Credit unions have such a big price spread versus the traditional banks,” he says.
One final word of advice: When you do your shopping with up to five different providers, do it all at once. That will minimize the impact of hard inquiries on your credit report, which may lower your score for up to two years.
What Is the Interest Rate on a Personal Loan?
Interest rates on personal loans can vary greatly based on your credit. In general, they start as low as around 6% and can go up to 36% or so. The average interest rate for a personal loan is 9.41%, according to the latest data from Experian.
For this article, I got quotes for a $10,000 personal loan from five providers — HSBC Bank, Marcus by Goldman Sachs, Prosper, Regions Bank and Upstart. You’ll see the rates below for loan terms of both three years (36 months) and five years (60 months):
|Provider||Monthly Payment||Estimated APR||Loan Term in Months|
|Marcus by Goldman Sachs||$313||7.99%||36|
As a general rule, it’s better to have a shorter loan term than a longer one for personal loans — and any kind of debt, really.
That’s because even though the monthly payment will be lower on a 60-month term vs. a 36-month term, you’ll wind up paying almost double in interest and fees over the life of the loan during the longer term.
What Are the Benefits of Obtaining a Personal Loan?
A personal loan can help you pay off high-interest credit card debt or make improvements to your home, among other things. Some people even use them to fund a vacation, which is not advisable.
The best use-case scenario here is that you can use a personal loan to get out from under back-breaking credit card debt that has a high interest rate.
You could treat one of these personal loans like a balance transfer offer, essentially. If you can lower the interest rate on an existing debt from double digits to a single digit, that can be a key part of a thoughtful strategy for relieving financial burdens in your life.
Are There Dangers to Getting a Personal Loan?
For many people, it may be better to secure a 0% APR balance transfer offer before going and getting a personal loan with an interest rate that could be in the double digits — depending on your credit.
If you do this, just be sure to wipe out your balance before the offer expires and the standard interest rate applies. Otherwise, you could end up with higher interest rates than you were paying to begin with.
Ultimately, it would be a huge mistake to take out a personal loan to pay off a high-interest credit card without also changing your spending behavior at the same time.
We’ve got monthly budget worksheets that use the CLARK Method to get your finances under control available for free right here. They can help you get started on a better path today.
Personal loans have both opportunities and pitfalls for consumers. As a general rule, you should try to get on a budget to come up with extra money to pay off your existing debt before getting a personal loan. But, taking out a personal loan could be the right move for some people in certain situations.
Meanwhile, if you have additional questions about personal loans, consider calling our Consumer Action Center.
Contact Clark’s Consumer Action Center — a FREE helpline open Monday-Thursday from 10 a.m. – 7 p.m and Friday from 10 a.m. – 4 p.m. EST. We have volunteers available to answer YOUR concerns! Call Team Clark @ 404-892-8227.
A personal loan is a short-term loan that typically runs from two to five years in length. It can be used to consolidate existing debt or pay off a large unexpected expense like health care, home repairs or the like.
Just as with credit cards, these loans fall into the category of unsecured debt. That means you don’t have to put up any collateral to be approved for a personal loan.
That means there’s nothing of yours that a creditor can physically seize or repossess if you stop paying on your loan. Still, your credit can be ruined if you’re late or default on your monthly installment payments.
How Do I Get a Personal Loan?
If you decide you want to apply for a personal loan, follow these simple steps to choose one:
Checking your credit report and credit score is easy. We’ve got guides to how to do that for free:
Meanwhile, calculating your debt-to-income ratio may sound difficult, but it’s really quite simple.
First, a bit of background: Your debt-to-income (DTI) ratio is a financial term used to determine how risky you are as a borrower.
Your DTI ratio is calculated by dividing what you owe each month (credit card bills, other monthly bills, student loans, other monthly debt obligations, etc.) by your monthly income. According to the Consumer Financial Protection Bureau, lenders do not want to see this ratio over 43%.
A co-signer may be required for a personal loan if your credit score is deemed too low or your DTI ratio too high.
Once you’ve done all that, you’ll want to make sure your credit is thawed before applying for a personal loan. We’ve got a full guide on how to do both credit thaws and freezes here.