From consolidating debt to paying for an unexpected event, a personal loan allows you to borrow money for almost any personal reason.
Estimated reading time: 8 minutes
Table of contents
- Check your credit score
- Decide on the amount you need to borrow and shop around for the best rates
- Consider other lending options
- Apply for the personal loan and if required, provide additional documentation
- Accept the loan and get it funded
- Important details to consider
- Frequently asked questions
Check your credit score
Your credit score is one of the most important factors when you apply for a personal loan. Lenders will pull your credit, and your score will tell them how likely you are to pay back the loan.
Although your income, debt-to-income ratio, and credit history play a role, knowing your credit score ahead of time will allow you to get a good idea of how much you can borrow, the interest rate you might pay, and calculate potential payments.
Most financial institutions offer free credit score tracking through their online portal or mobile app. If you don’t have that option, you can use Credit Karma or a similar resource that provides free credit score tracking.
When you get your score, determine whether or not it seems correct. If it’s drastically lower than what you were expecting, get a free copy of your credit report from AnnualCreditReport.com.
Once you get the report, look for errors. If you find any, report them to the credit bureaus so that they make the adjustments.
Decide on the amount you need to borrow and shop around for the best rates
Once you have an idea of what your credit score is, decide on the amount that you need and look for the best rate that you can find.
When you’re figuring out how much you want to get a loan for, the most important thing is the ability to pay it back.
Before applying for a loan, determine how much you need, approximate interest rates, terms, and payments. By doing the calculations ahead of time, you’ll be well prepared to take on the personal loan.
As you shop around for rates, take notes on how the rate changes with different amounts and terms. You can contact or visit your financial institution and provide them your estimated credit score and loan amount to run the approximate numbers.
Talk to different lenders so that you have enough data to make a good decision and figure out which lender is giving you the best deal.
Consider other lending options
Sometimes a personal loan isn’t the best option. That’s why the purpose of the loan matters. Are you using it for home improvement, debt consolidation, making a large purchase, or something else?
If your goal is to use a personal loan for home improvement, some financial institutions won’t allow you to get a personal loan. Instead, you’ll need to apply for a home improvement loan.
However, you should check with your potential lender if you can use the personal loan for home improvement. If you can, and they offer you a better rate, then go for it.
Credit card debt consolidation
Another example where you can save more money going down a different route is with credit card debt consolidation.
For example, let’s say you have $5,000 in credit card debt and wanted a personal loan with an interest rate of 9.41%, which is the average according to Experian.
If you chose to do a 12-month term for the personal loan, your monthly payment would be $438.21. Over the life of the loan, you’d pay a total of $258.50. Therefore, the total amount you’d pay back to the lender would be $5,258.50.
Instead of choosing a personal loan, you can do a balance transfer to another credit card that offers 0% annual percentage rate for the first 12 months. Before you apply for a new card, check to see if any of the credit cards you have are offering a balance transfer promotion.
If you did a balance transfer and paid the full $5,000 in the same 12-month term, you’d pay no interest, which saves you $258.50.
That said, explore the other options before deciding to go down a specific path. You may be able to save money on interest, and put it towards your savings account.
Apply for the personal loan and if required, provide additional documentation
If you’ve done the calculations and feel confident in getting the personal loan, it’s time to apply. Most lenders allow you to apply online, in person, or over the phone.
The application will consist of your personal information, such as the following:
- Full name.
- Social security number.
- Mother’s maiden name.
- Date of birth.
- Employer, occupation, and income.
- Monthly debt payments, such as rent, and other loans.
Once you apply, you may also need to provide additional documentation for a variety of reasons. The lender may request your social security card to verify the number, a utility bill to verify your address or income verification documents.
Although each lender is different, the following are common documents that are required for income verification:
- Tax returns
The exact documents will depend on your situation and the lender’s requirements for verification.
Accept the loan and get it funded
If you get approved, congratulations, now it’s time to get the funds. Once you hear that you’re approved and that everything is ready for funding, you can accept the loan.
At this step, you’ll also finalize the term, interest rate, payments, and details of the loan. If you don’t currently have an account with the lender, establishing an account may be a requirement, as well.
Depending on the lender, finalizing the loan can occur the same day or within a week. Most financial institutions can fund the loan immediately after everything is approved and finalized.
However, it may take longer. Therefore, account for the worst-case scenario when it comes to the time-frame.
If you have an account with the lender, you may be able to get the funds directly deposited into your checking or savings account. The other way to get the funds for a personal loan is a cashier’s check.
If you’d like the financial institution to consolidate your credit card debt on your behalf, ask if it’s a possibility, then provide the following details:
- Full account number.
- The amount that you’d like to consolidate.
- Payment address for the card you’d like to do a balance transfer on.
- The financial institution’s name and phone number.
After it’s funded, you’re ready to make the payments. Make your payments on time to ensure that nothing is reported negatively on your credit report.
Important details to consider
There are regulations that lenders and financial institutions must follow. Personal loans are considered closed-end credit.
The Consumer Financial Protection Bureau (CFPB) requires that all of the information regarding interest rates, charges, loan amounts, total payments, and other details related to the loan be disclosed (Source: CFPB Subpart C).
The following are details to make sure you understand and are provided information for:
1 Amount financed. Make sure the principal loan amount is correct. You don’t want to borrow or pay for more than you need.
2. Prepayment penalties. A prepayment penalty is a fee that a lender charges if you pay off the entire or a large part of your loan early. Make sure the lender you go with doesn’t charge prepayment penalties, and if you can, pay off your loan as soon as possible.
3. Autopay and potential discounts. Setting up automatic payments is a great way to ensure that you’re not late on a payment. Life can get busy, and something urgent might come up, that’s why autopay is a helpful choice. Some financial institutions offer discounts on your rate when you set up an automatic payment. Although that’s not the case for every lender, it wouldn’t hurt to ask.
4. APR and origination fees. The APR, or annual percentage rate, is the cost of credit shown at a yearly rate. It’s the percentage that you’ll pay yearly for the loan. The APR needs to be clearly stated, and if there are origination fees, you need to be aware of that as well.
5. Is the rate variable or fixed? Most personal loans have a fixed rate, meaning your interest rate won’t change. Some lenders offer a variable rate, which means the rate can change, and it’s riskier, especially if the rate increases. Regardless, it’s important to understand the type of rate you have.
Frequently asked questions
Credit unions or local banks generally offer the lowest rates for personal loans. Normally, online lenders are more expensive, but you may be able to find promotions or good interest rates by searching.
It’s possible to get a loan with bad credit. However, the interest rate will be higher, you’ll be limited with the amount you can borrow, and the term to pay it back will likely be shorter.
A personal loan is an unsecured form of credit, meaning the loan isn’t guaranteed by a physical item.
Getting a personal loan can help you consolidate debt or cover unexpected expenses. However, the key is to find the lowest interest rate and borrow only the amount that you need. When you combine those with making your payments on time and paying it off as soon as possible, you’ll be in good shape.
Featured image courtesy of Pexels.
About David Em
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.