Over the past few years, personal loans have been a hot topic. Personal loans can be used for almost anything: home improvement projects, consolidating your high interest rate debts, car repairs, relocation costs, weddings, and even vacations. From 2013 to 2015, personal loans have grown 18% according to Transunion.
Most of the loans are unsecured, which means it’s not tied to any of your assets. Secured loans such as home equity line of credits (HELOCs) and title loans are collateralized by tangible assets.
Lenders such as Avant, Prosper, and LendingClub typically do all their online application and underwriting online, so getting access for a personal loan is a lot quicker and simpler than before. If you’re thinking about getting a personal loan, here are five things to consider:
Don’t Stretch Your Budget, Take What You Need
This is perhaps the most important thing to remember when getting a personal loan. Depending on the amount, you’ll now have an extra expense every single month. A $5,000 personal loan at 15% APR for 3 years will cost you around $173/month. It may not seem like a lot initially, but you might find that this extra $173/month is actually causing some serious strain on your monthly budget.
Personal loans are designed to help you get the cash you need during dire times. Whether it’s to consolidate debt or pay for a wedding, you need to make sure you can comfortably repay the loan. Almost all online lenders will report your payment history to the credit bureaus, so it’s important not to default on these loans.
When you’re applying for a personal loan, your application will determine how much you actually qualify for. You can choose up to the maximum amount you’re qualified for. If you were only looking for $5,000 but got qualified for $8,000, take only what you need.
Watch Those Origination Fees
Origination fees are fees charged by the lender for issuing the loan. It can range anywhere from 1-6%. For example, if you apply for a $5,000 loan with a 5% origination fee, $250 will automatically be taken out of your loan. So the actual loan amount you receive will be $4,750.
These origination fees can add up. If you plan to pay off the loan before the end date, your APR will be a lot higher, so sometimes it’s better to take out a higher APR loan without origination fees.
Calculate Cost Savings
If you’re taking out a personal loan to consolidate debt, only take out what you need. Before applying for a personal loan, you should look into a 0% balance transfer APR. However, these cards typically will require a much higher credit score.
A personal loan can help expedite your ‘get out of debt’ journey. Unlike credit cards, the interest rates on personal loans are amortized. This means that you’ll have a fixed payment for a set period of time. Your payments will never increase and you’ll know exactly when you’ll be debt free. The reason why a personal loan can help you get out of debt faster is because credit card interest rates are calculated based on the average daily balance method.
Creditors will charge you interest every month based on what your average balance is, so if you’re paying off your credit cards but still accumulating debt, your balance won’t decrease as fast. To figure out if a personal loan is right for you, you can use a debt repayment calculator to figure out how long it’ll take you to become debt free and compare it to a personal loan.
Be Mindful Of Your Credit Score
It’s also a good habit to stay on top of your credit score. The average credit score is around 695. If your score isn’t in the best shape, it might be worthwhile to hold off on applying for a personal loan until you’re confident that your credit score will get you the best rate possible.
There are many free credit score options out there such as Credit Sesame & Credit Karma that provide you your score free of charge. Keep in mind that free credit monitoring services like Credit Karma will provide you with your Vantage Score and not your actual FICO Scores. There are various credit models out there (Vantage, FICO, TransRisk, etc) and each lender will use a different one. Some lenders will list out their minimum credit score while others don’t necessarily have a minimum score requirement.
It also doesn’t hurt to apply for a secured credit card to improve your score since this is one of the most proven ways to do so.
Waiting a month or two before you apply for a loan isn’t the worst idea and in fact, it might be the right choice depending on where your credit stands today.