Why You Need a Personal Loan
You can use a personal loan for a variety of bigger expenses. You can start or invest in your business, buy a used car, consolidate high-interest credit cards, make improvements to your home, or even go on an once-in-a-lifetime vacation.
However, you need to know the different types of personal loans and which one you can qualify for before you apply.
Types of Personal Loans
Basically, personal loans come in three forms. Here’s an overview.
- Secured personal loans are attached to collateral. Collateral is an item that has some value, like a car or a piece of expensive jewelry. If you don’t pay the loan, the lender repossesses (or takes back) the collateral. Most auto loans fall under this category.
- Credit-based personal loans depend on your credit rating or score. Since the loan is not secured by collateral, you usually need to have an excellent credit score – above 720 or higher – to get a low interest rate. Some lenders may take lower scores, but charge higher interest rates.
- Paycheck-based personal loans hinge on your job and your monthly income. Typically, the lender does not review your credit. You can get approved for these loans faster and easier than the others, but you’ll have to pay them back quicker and you’ll have a higher interest rate. Usually, borrowers use these loans to take care of short-term emergencies.
Which Loan Should You Apply For?
How you answer these four questions will determine, which loan fits you best.
- Do you have collateral that is valuable?
- Do you have an excellent credit score?
- Do you have a low credit score, but a good job with a consistent paycheck?
- What are you using the loan for?
Buying a Car
If you’re buying a car, a loan secured with the car is a good place to start. Try to get approved at a bank or credit union before you use the dealership – as most dealerships charge higher interest rates. You’ll still need a good credit score.
However, if you need to put down money on the car, you could also use a personal loan based on your credit or your paycheck for that. If your credit score is high try the credit-based personal loan. Otherwise, the paycheck loan is your best option.
Starting or Investing in a Business
Typically, you need good credit and a strong business plan or profitable business to get a business loan. The bank will also require some type of collateral. But, if you’re facing a short-term financial crisis in your business and need less than $1,000 a personal or job-based loan is your best bet. Again, if you have excellent credit rating, apply for the loan based on your credit score. If not, you may have to use your job and income to qualify.
Consolidating Credit Cards
You should use a personal loan to consolidate your credit cards only if the interest rate on the personal loan is lower (usually at least 1% or more) than your credit card interest rates. Or, you want to pay more than the minimum payment and get the balances paid off in around 24 months. This strategy only works if you can get a longer-term personal loan. To receive approval at a low interest rate, you’ll need an excellent credit score. (Go here for more information on debt consolidation loans.)
Home improvement loans should also be set up as a longer-term personal loan. The one exception is lower-cost crisis repairs that need to get done immediately to make the house livable. Many times these are covered by your homeowner’s insurance, but some do not reimburse you until the repairs are completed. In this case, a short-term personal loan could make sense. The rule of thumb is if you have excellent credit apply for the lower-interest personal loan. Otherwise, use the short-term job and income-based loan.
If you want to go on vacation, the best thing to do is save your money. If you decide to take a loan, make sure the interest rate is low and the payment terms are longer (12 to 24 months). This insures you don’t put yourself in a bad situation.
Obviously, a short-term, paycheck-based loan works best if you have a bad credit score, but a job and consistent income. It also makes sense when you face financial emergencies, including car repairs that keep you from work; electricity, gas, water and other necessary bill payments; and pending overdraft fees. These loans are also the easiest and fastest loans to get.