Millions of Americans borrow personal loans to consolidate debt, cover unexpected expenses, tackle home improvement projects, and even start businesses. And while getting a personal loan is relatively easy, and a personal loan can be a solid way to get some quick cash (see the latest personal loan rates here), it’s not something to be taken lightly and it can end up costing you dearly. Here are six things experts say you should know before taking out a personal loan.
1. Understand the application process
To get a personal loan, you will complete a loan application and show proof of your identity, address and income. The lender may request items such as W2, pay stubs, 1099, bank statements, tax returns, utility bills, mortgage statements, driver’s license, passport, etc.
While that may seem like a lot, the good news is that personal loans tend to fund up pretty quickly. “Personal loans offer a quick and easy application process, especially compared to the long and tedious experience of applying for a home equity line of credit or refinancing your mortgage. It’s often possible to apply for a personal loan online within minutes and if approved, you can get the funds the next day,” says Ted Rossman, senior industry analyst at Bankrate. This guide will tell you how to get a personal loan.
2. Consider other options
“It is essential to know the other options before obtaining a personal loan to be sure that it is your most affordable option. In some cases, promotional credit cards or home equity financing could help you achieve your goals and save money,” says Annie Millerbernd, personal loan expert at NerdWallet. This is because rates on HELOCs and home equity loans tend to be lower than those on personal loans. This guide highlights the differences between a HELOC loan and a home equity loan if you are considering one of them.
If you are using a personal loan to pay off debt, you may find that sometimes a debt management plan offered by a reputable non-profit credit counselor will include more attractive terms than a personal loan, especially if you have less than perfect credit. “Many people can qualify for something like a 5-year repayment period with a 7% interest rate when consolidating higher-cost credit card debt,” Rossman says.
3. Know where to find the best rates
Online lenders — especially fintechs — often offer the best rates, pros say. “But it makes sense to also include some traditional banks and credit unions in your search. Rates vary so much that you absolutely have to shop aggressively for the best deal,” says Rossman. (Check here for the best personal loan interest rates you may qualify for.)
There’s no reason to get a personal loan without knowing roughly what rate to expect, says Millerbernd. “Prequalify with a lender before submitting an application to preview your loan offer. Since pre-qualification doesn’t affect your credit score, you can shop around with multiple lenders before settling on one,” says Millerbernd.
4. Find out about other costs you may incur
Do not just look at the rate you will be charged, but also the fees. For example, many personal loans include origination fees, which typically range from 1% to 8%. “It’s something you should incorporate into your research process when shopping. Also, origination fees are usually deducted from the loan amount, so if you need $10,000, but there is an 8% origination fee, you really need to ask for close to $11,000,” explains Rossman.
5. Understanding how personal loans work
A personal loan is a loan from an online lender, bank, or credit union, usually for amounts between about $1,000 and $100,000. you usually repay them at regular intervals, such as monthly, over a period of one to seven years.
Personal loans are generally unsecured debt, so you don’t usually have to put an asset such as your home or car as collateral directly. You will receive the money in a lump sum, and lenders are usually not so strict about what to do with the money. Just note that if you don’t repay the loan, you will damage your credit score.
That said, if you are having difficulty repaying your personal loan, there are instances where you can take out an additional loan to help pay off the old one. “It might make sense if you can lower your interest rate, but be careful of the fees for getting the new loan started,” says Rossman.
6. You are unlikely to be hit with a tax bill related to your personal loan
“Generally, there are no tax implications when taking out a personal loan, as it is not considered income. If you end up getting a portion of the loan canceled or forgiven, only then does that amount become taxable as income,” says Matt Schulz, chief credit analyst at LendingTree.