If you need some extra cash to pay for a home improvement project, a medical bill, a vacation or any other personal expense, you may consider taking out a personal loan. But what is a personal loan and how does it work?
A personal loan is a type of debt that you can use for almost any purpose. You borrow a fixed amount of money from a lender and agree to pay it back over a certain period of time, usually with interest.
There are two main types of personal loans: secured and unsecured. A secured personal loan requires you to provide some form of collateral, such as your car or your home, that the lender can take if you fail to repay the loan. An unsecured personal loan, on the other hand, does not require any collateral. Instead, the lender bases its decision on your credit score, income, debt and other factors.
Pros and Cons of Unsecured Personal Loans
Unsecured personal loans have some advantages and disadvantages compared to secured personal loans. Here are some of them:
Pros:
- You don’t risk losing your assets if you default on the loan.
- You can use the money for any purpose you want.
- You may get faster approval and funding than with a secured loan.
Cons:
- You may pay higher interest rates than with a secured loan.
- You may have lower chances of getting approved if you have bad credit or low income.
- You may face fees and penalties if you miss payments or pay off the loan early.
How to Get an Unsecured Personal Loan
If you decide that an unsecured personal loan is right for you, here are some steps to follow:
- Check your credit score and report. Your credit score and report are key factors that lenders use to determine your eligibility and interest rate for an unsecured personal loan. You can get a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion) once a year at annualcreditreport.com. You can also check your credit score for free on various websites and apps, such as NerdWallet. If you find any errors or negative items on your credit report, you should dispute them or work on improving them before applying for a loan.
- Shop around for the best deal. Different lenders may offer different terms and rates for unsecured personal loans, so it’s important to compare multiple options before choosing one. You can use online tools and platforms, such as Credible, LendingTree or NerdWallet, to see personalized offers from multiple lenders based on your credit profile and needs. You can also check with local banks and credit unions, which may have lower rates and more flexible criteria than online lenders.
- Apply for the loan. Once you find a lender that suits your needs, you can fill out an application online or in person. You will need to provide some personal and financial information, such as your name, address, income, employment, debts and expenses. You may also need to provide proof of identity, income and residence, such as your driver’s license, pay stubs and utility bills. The lender will then run a hard credit check, which may lower your credit score slightly, to verify your information and make a final decision.
- Receive the funds and start repaying the loan. If you are approved for the loan, the lender will send you a loan agreement that outlines the terms and conditions of the loan, such as the amount, interest rate, repayment schedule, fees and penalties. You should read this document carefully and make sure you understand and agree with everything before signing it. Once you sign the agreement, the lender will transfer the funds to your bank account or send you a check within one to five business days. You will then start making monthly payments according to the agreed schedule until you pay off the loan in full.
Tips for Getting an Unsecured Personal Loan
Getting an unsecured personal loan can be easy if you have good credit and income, but it can be challenging if you don’t. Here are some tips to help you improve your chances of getting approved and getting a good deal:
- Improve your credit score. A higher credit score can help you qualify for lower interest rates and better terms on an unsecured personal loan. To improve your credit score, you should pay your bills on time, keep your credit card balances low, avoid applying for new credit too often and monitor your credit report for errors or fraud.
- Reduce your debt-to-income ratio. Your debt-to-income ratio is the percentage of your monthly income that goes toward paying your debts, such as credit cards, student loans and car loans. A lower debt-to-income ratio can show lenders that you can afford to take on a new loan and repay it on time. To reduce your debt-to-income ratio, you should pay off or consolidate your existing debts, increase your income or lower your expenses.
- Choose a shorter loan term. A shorter loan term means that you will pay off the loan faster and pay less interest overall. However, it also means that you will have higher monthly payments, which may strain your budget. You should choose a loan term that balances your affordability and savings goals.
- Consider a co-signer or a joint applicant. A co-signer is someone who agrees to repay the loan if you can’t, while a joint applicant is someone who applies for the loan with you and shares the responsibility and ownership of the loan. Having a co-signer or a joint applicant with good credit and income can help you get approved for an unsecured personal loan and get a lower interest rate. However, you should only do this if you are confident that you can repay the loan on your own, as failing to do so can damage both your and your co-signer’s or joint applicant’s credit and finances.
Bottom Line
An unsecured personal loan can be a useful tool to finance your personal needs without risking your assets. However, it can also be expensive and risky if you don’t manage it well. You should only take out an unsecured personal loan if you have a clear purpose and a realistic plan to repay it. You should also shop around for the best deal and compare it with other financing options, such as secured loans, credit cards or savings.