When it comes to personal loans, you definitely have many options to choose from. Besides traditional banks and credit unions, you can also take out a loan from several online lenders that can help a wide range of borrowers- from the creditworthy to the credit-challenged ones.
However, the real challenge is finding the best personal loan for you.
Note: I only recommend getting personal loans to consolidate debt or to cover medical bills and other extreme circumstances that can lead to bankruptcy.
When possible, avoid borrowing money by paying cash, reducing expenses, and delaying purchases. Sometimes life happens, but try the debt-free route first.
Knowing What Personal Loans Are
Personal loans, also known as installment loans, can provide you with the immediate financial assistance you might need. When you apply for one, you ask to borrow a certain amount of cash from a lending institution of your choice, such as a bank, credit union, or even from online lenders.
You can use this loan option for a variety of purposes. Since it can be paid by installment, you’ll be given a set period to pay back the total amount of the loan with interest.
Below are the typical loan terms you should know about before applying for a personal loan:
- Principal. The principal refers to the specific amount you want to borrow. Suppose you apply for a loan worth $15,000, that same amount is considered your principal. When the lender you chose calculates the loan’s interest, they will base the computation on the principal that you owe. Also, paying your personal loan debt per month means your principal amount will decrease over time.
- Interest. Taking out a personal loan means you agree to repay the debt, including the interest. The interest is considered the lender’s “charge” for letting you borrow money and repay it for some time. This means that you will have to pay interest in addition to your monthly payment, which decreases the principal.
- Annual Percentage Rate (APR). Lenders might also charge fees for your loan application besides the principal and interest rate. APR combines all of the lender’s fees as well as the interest rate of the loan. Comparing APR can be a great way to compare the value and affordability of many different personal loans.
- This refers to the number of months you have to pay back the loan. When your loan application is approved, the lender will present the interest rate and the term of the personal loan they are offering.
What Lenders Look At When You Apply
To get the best loan offers, you must know what lenders are looking for in your loan application. The following are the factors lenders look into when you apply for a personal loan:
Lenders tend to look at your credit score because it can give them a glimpse of how you handle borrowed money. If you have a poor credit score, you have an increased risk of defaulting on the loan.
This is usually why some lenders are hesitant to let you borrow money since they might not get back the money.
Credit scores usually range from 300 to 850. The higher your credit score, the better. This means that if you want to get the best loan offers (bigger loan amount with low interest rate), you need to boost your credit score.
Income And Employment History
Lenders want to make sure that you’ll be able to repay them. Hence, they tend to evaluate your income and employment history. They want to see if it is sufficient and consistent enough to repay the money you want to borrow.
Income requirements usually depend on the loan amount you want to borrow. However, if you borrow more money, this typically means you might need a higher income to convince the lender for loan approval.
Your debt-to-income ratio is closely related to your income. This pertains to the ratio of your monthly income and your monthly debt obligations. Lenders typically want you to have a low debt-to-income ratio; below 43% would suffice.
If you have a debt-to-income ratio that is higher than 43%, there’s still a chance for you to get a loan. However, you’ll need to have a high income and an excellent credit score. Unfortunately, some lenders don’t take this risk and automatically reject your application if you have a high debt-to-income ratio.
Your current financial situation may not change in two or three years. However, after five or more years, it may change a lot. Lenders will surely be more confident in lending you money that will be repaid in a shorter period because you’ll most likely pay it back in the future.
A shorter loan term can help you save money because you’ll only pay interest for a few years. But, you’ll have a higher monthly payment. That is why you need to weigh this factor before you finally decide which loan term is great for you.
Related: Learn more about consolidating credit card debt.
To Sum It Up
You will have plenty of options when it comes to getting a personal loan. A wide variety of lenders can help you with the specific amount you need. However, getting the best personal loan that won’t harm your finances should be taken into consideration at all times when shopping around.