Personal loans are unsecured loans, ideal for covering unforeseen as well as planned expenses when savings fall short of cash. Unsecured loans, available from direct lenders, banks and credit unions, charge high interest rates as they are not backed by collateral, unlike secured loans, where a pledged asset can be repossessed in case of default.
Short-term personal loans aimed at funding small emergencies are discharged in one fell swoop. Therefore, the repayment duration does not last beyond a month. However, long-term personal loans used to consolidate debts and renovate houses are paid down over an extended duration. They spread the cost of the debt, which makes them more manageable than their short-term, high-cost counterparts.
What do you need to qualify for a personal loan?
Qualifying for a personal loan is not easy, especially if the borrowed sum is large. Your credit score should be decent. Borrowers with subpar credit ratings are not precluded from submitting loan applications, but they struggle to receive approval for lower interest rates.
In addition, you will need to prove your repayment capacity. You can improve your chances of making your application a success by avoiding owing any debt currently and having at least a fair credit score and strong financial condition.
Different lenders charge different interest rates depending on how risky your credit profile is perceived. Experts enjoin that you compare personal loans before entering into an agreement.
When does it make sense to take out a personal loan?
The following are the financial situations when personal loans are recommended:
Debt consolidation
Having multiple high-interest debts could be quite challenging to handle. Here comes the role of personal loans. You take out a personal loan to pay off all your outstanding debts once and for all, so you are left with only one large loan to be paid down over an extended period. Personal loans, spreading the cost of the debt, might be available at lower interest rates than short-term debts.
It is essential to bear in mind that personal loans consolidate only high-interest debts, which are paid off in a lump sum. You can avoid rolling over and accumulating the debt by consolidating all of them into one large personal loan. You will have to deal with instalment loans such as mortgages and auto loans separately.
Personal loans do not include credit card balances. You will have to apply for a balance transfer card in case you are struggling with outstanding balances on multiple credit cards.
There is no guarantee that a lender will consolidate all short-term high-cost debts. It means you might still have to deal with some loans separately despite consolidation.
You must have a good credit score in order to be accepted by a lender. Most lenders accept applications from borrowers with stellar credit histories. Subprime borrowers can also get the nod, but the loan amount will be restricted, and interest rates will also be high.
Sometimes, consolidation does not help save you any penny especially if not all debts are consolidated. Compare the cost of a personal loan with that of loans to be paid off separately before making a decision.
Emergency loans
Life throws a curveball. Various expenses can catch you off guard. Maybe you need some money to pay off medical bills, or maybe you need the money to make arrangements to travel abroad to attend someone’s funeral. Personal loans can provide you with quick access to cash.
Bear in mind that the APR of small emergency loans are quite high, and they are discharged in one shot. It is always recommended that you borrow what you need. There is no point in borrowing more money, even though you can afford the payments, as it will cost you more in interest.
Sometimes, you may be compelled to borrow less money than you can actually need as your budget is thin. Experts suggest that you borrow money as per your affordability.
Home improvement
Personal loans can come in handy to take on a home renovation project. Whether you need to give a fresh coat of paint to the walls or you need to conduct a major improvement, such as an attic conversion, personal loans can help you cover the cost. It especially benefits those who have not built home equity.
Home improvement projects like kitchen and bathroom upgrades can be easily managed by personal loans. However, interest rates for these loans will be quite a bit higher than secured home improvement loans. Carefully analyse your repayment potential before using these loans.
When taking out personal loans cannot be a good idea?
You can use personal loans to meet small emergency expenses, but they should be one-off costs. On no account should you use these loans for recurring expenses. For instance, borrowing money to pay rent can trap you in an ongoing cycle of debt.
Do not use personal loans when your income is not stable, or you are not confident about your repayment capacity. Even if you need money urgently, borrowing is not advisable if you cannot pay it back on time.
Personal loans cannot be an ideal choice to meet discretionary expenses. Funding impulsive buying will throw you into an abyss of debt.
Research cheaper alternatives as well. Borrowing from friends and family, budgeting loans, and credit union loans might prove to be cheaper alternatives than personal loans.
What factors should you consider before applying for personal loans?
Here are the factors that you should consider before taking out unsecured loans:
- Look at interest rates. They determine the total cost of the debt. Consider fees and other charges as well.
- A longer repayment plan will cost you more interest in total than loans with a shorter repayment plan.
- Check your credit score before applying so you don’t approach a lender that requires a higher score.
- Assess your repayment capacity so you do not borrow more than your repayment capacity.
Tips for taking out personal loans
In order to have an affordable personal loan, you should follow these tips:
- Borrow only what you need and are certain you can repay.
- Compare lenders. Check deals from credit unions, banks and specialized lenders.
- Read the fine print carefully.
- Adhere to the repayment plan.
The final word
Taking out a personal loan makes sense when you need money to meet unexpected one-off costs, consolidate existing debts, and renovate your house. Use these loans for emergencies when cheaper alternatives are not available. Make sure that you do not use them for discretionary and recurring essential expenses either.
