Personal Loan Options

    Personal loans are a popular form of borrowing for home remodeling, vacation travel, weddings and emergency situations. Personal loans usually don’t require collateral and can be used at the borrower’s convenience and discretion.

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    Personal loans used to be simple part of the American economy. Homegrown savings and loans lent money to buy boats and barbeque pits based on the reputation of their customers. If you had a job, paid your bills on time and were known to be honest, there was loan money available.

    Personal lending has changed -- a lot. In today’s mass society, giant national and regional banks rule and loan underwriting is anything but personal.

    Though banks still make open-ended loans to their best customers, the review process can be difficult and the terms might discourage all but the most determined customers. Today’s borrowers often turn to family members, friends and peer-to-peer lenders for personal borrowing.

    Most personal loans lack collateral – property that can be taken if the borrower defaults – so they rely on the integrity of the borrower to repay the loan’s principal and interest. In many cases, lenders do background and credit checks on potential borrowers to assess their risk.

    A personal loan is usually unsecured. This kind of loan is used for everything from funding an education or financing a new business venture to purchasing luxury items or taking a lavish vacation. Unsecured loans are made without collateral, so lenders consider them risky. Credit card debt is unsecured, since the lender has nothing to seize if the borrower defaults.

    A secured loan uses an asset, usually a house or car, as collateral. If the borrower defaults on the loan, the creditor can take the asset. Lenders can seize property with secured loans, like home mortgages and car loans. The lender can foreclose the home or repossess the car if the borrower stops making payments.

    Personal loans have evolved over the years to meet the changing needs of the consumer. It used to be nearly impossible to get a personal loan with a limited or poor credit history, but today there are loan options for people with bad credit and those without a detailed financial track record.

    Benefits of Choosing a Personal Loan

    One benefit of a personal loan is in the name: It’s personal. You can use it for any reason you like and you often don’t need collateral to get one.

    You can use personal loans to cover practical expenses like consolidating credit card debt or remodeling a bathroom to something whimsical like buying a boat or taking a European vacation. The choice is yours.

    Personal loans, especially unsecured ones, usually require an application and verification of your financial standing. Though banks or credit unions make personal loans, the new trend is toward less conventional lenders.

    Family and friends can be the source of money, though it is advisable to have a formal loan agreement with them to make sure the relationship doesn’t go sour.

    There also are many peer-to-peer online lending sources like Prosper and Lending Club, as well as sites like Kickstarter.com and IndieGoGo.com that cater to entrepreneurs. The online sites normally charge a fee, but if you need money quickly they represent an option.

    Other benefits of personal loans:

    • You get the money faster. In most cases approval is much quicker than with conventional loans.
    • Don’t need a bank. The money could come from a credit union, an online lender, a family member or friend.
    • Fixed rate interest, fixed length of repayment and fixed monthly payments.
    • Loan amounts available from $1,000 to $100,0000.
    • Lower interest rates than credit cards.
    • If loan comes from a bank, possible discounts on interest rates.

    Personal Loan Knowledge

    It’s a good idea to become acquainted with loan terminology before applying. There is language in the application that you should be familiar with before you sign an agreement.

    Below are some financing terms that are commonly used in the personal loan arena:

    • Credit history: a record of how a consumer has borrowed and repaid debt. Commonly referred to as your credit report.
    • Lender: the entity that makes funds available for borrowing.
    • Debt: money that is owed.
    • Asset: an item of ownership that has exchange value.
    • Collateral: the pledge of an asset to a lender to secure repayment of a loan.
    • Fair Market Value (FMV): the amount something would sell for on the open market.
    • Term: period of time between the initial procurement of the loan and the time the loan is repaid in full.
    • Equity: the difference between the fair market value of an asset (e.g. home or automobile) and the amount still owed on the loan.
    • Home equity: the difference between the market value of a home and the outstanding mortgage balance.
    • Home equity line of credit (HELOC): a credit line that uses equity in one’s home as collateral. Typically, a borrower can access the credit line for 10 years, then either refinance the loan or pay back the borrowed amount. Since HELOCs are collateralized, they typically charge less interest than unsecured loans.
    • Home equity loan: a loan against the equity in one’s home. Home equity loans are usually earmarked to pay for something specific, often a home improvement project.
    • Interest: the cost of borrowing money.
    • Interest rate: percentage of a loan that will be paid back as interest.

    Types of Personal Loans

    Lenders offer a wide array of personal loans to satisfy various needs. Your financial condition, whether you own a home and your military status, can influence the type of loan you receive.

    The seven most common types of personal loans are:

    • Home Equity Personal Loan: lump-sum loan secured by your equity in your home.
    • Home Equity Line of Credit (HELOC): revolving amount taken as needed and secured by the equity in your home.
    • Short-Term Personal Loan: taken when funds are needed urgently.
    • Fast Cash-Advance (or Payday) Loan: taken when funds are needed immediately. Such loans often come with very high interest rates and difficult repayment terms.
    • Military Payday Loan: specific to men and women in the military.
    • No Credit/Bad Credit Personal Loan: for consumers with a bad or limited credit history.
    • Second-Chance Personal Loan: for a financial crisis or personal tragedy.

    Peer-to-Peer Lending

    Peer to peer loans, also known as P2P, person to person or social loans – have become an important source of borrowed money in the internet age. An assortment of web sites specialize in connecting those needing loans with investors willing to lend money.

    Several companies, including Lending Club. Lending Tree and SoFi, are major peer-to-peer lenders and have worked to standardize lending practices. The company lures investors with favorable rates of return, then loans the invested money to borrowers. Lending Club only deals with borrowers with good and above average credit scores and charges an origination fee of 1% to 6% of the loan’s value.

    Some borrowers use peer-to-peer loans to pay off higher interest debts like credit cards or possibly Buy Here Pay Here auto loans. Lending Club, for instance, charges rates from 5.99% to 35.89%. The loans allow early repayment without penalty.

    Peer-to-peer lenders typically use borrowers’ debt-to-income ratios, income, financial history and career experience to decide to whom they’ll lend. Some lenders will advance as much as $100,000, though typically loans are for $35,000 or less.

    Consider these pluses and minuses before applying for a peer-to-peer loan:

    • Loans can be used in place of second mortgages or home equity lines of credit (HELOCs) for needed cash. Unlike bank real estate loans, they don’t require collateral nor is the application cumbersome.
    • Interest rates can be lower than other forms of financing, especially debt accrued on credit cards.
    • Investors who fund peer-to-peer loans find them attractive because the rate of return can be substantially higher than on conventional investments.
    • Loans can be risky. Though loan facilitators do extensive background checks on borrowers, collection can be difficult. Since the loans aren’t insured, the lender bears all the risk. Generally, lenders protect themselves by restricting the amount they’ll loan to any one borrower.

    Borrowing from Family and Friends

    Family members can be a valuable source for borrowing money. Whether the loan is used to make it through a rough patch, make a down payment on a house or start a new business, family and friends can offer invaluable help for reaching your financial goals.

    Family lending is huge in the United States. The Federal Reserve Board reports loans from family and friends total about $89 billion a year. Though family members can be a huge help, borrowers often don’t repay their generosity. CNN Money says that about 70% of loans made by family and friends are either partially repaid or not repaid at all.

    This most personal form of borrowing should be thought through and terms should be set – in writing. A loan contract should include the amount borrowed, the interest rate if one is charged, and the repayment terms. The agreement should also spell out the lender’s recourse if the borrower defaults. That includes restructuring the loan or taking legal action.

    Understanding the transaction is key to both the lender and the borrower. Remember the difference between a loan and a gift. Loans come with promissory notes, and they must be reported on tax returns. The Internal Revenue Service requires that interest be paid on lent money. When you devise of loan agreement, make sure it includes an amortization table that spells out how much interest must be paid and sets out a schedule for payments.

    Better Choice: Secured or Unsecured Personal Loan?

    There are benefits and drawbacks to both sides of the argument over whether to take a secured or unsecured loan, but the final decision comes down to answering two questions:

    • Do you have a valuable piece of collateral, typically a home or automobile?
    • Are you willing to risk losing that asset if you can’t make payments on the loan?

    If you can answer “Yes” to both questions, a secured loan is the route to take. There are many more benefits to a secured loan for the obvious reason that you stand to lose a lot if you don’t make payments. Additional benefits include:

    • It’s easier to qualify for a secured loan because you have collateral.
    • You should receive a better interest rate. The collateral used to secure the loan has value, which makes you less of a risk. The lower the risk, the lower the interest rate on the loan.
    • You should be able to borrow more money, based on the value of the collateral.
    • You may not need a job. Lenders prefer the borrower to have a job, but if job loss is the reason for the loan, employment is less of a factor, especially if there is good collateral backing the loan.

    The primary benefit of an unsecured loan is that you won’t lose any assets, meaning home or car, if you can’t make payments. Additionally, unsecured loans are easier to dismiss in bankruptcy court.

    Applying for a Personal Loan

    The application process for personal loans should be easy, as long as you answer the questions in detail and can verify your work and credit history.

    Before you start filling out the application form, take a few minutes and answer some questions:

    • What is the purpose for the loan?
    • What is your credit score and what type of interest rate do you expect to receive based on that score?
    • How much are you going to borrow and can you comfortably afford the payments on that amount?
    • How long a repayment schedule can you handle and do you want a secured or unsecured loan?

    Once you have the answers, gather documents required to verify financial information. You may need tax returns, checking and savings account information, deeds for property and titles for cars. You may need all or parts of that list, depending on the size of loan you’re seeking.

    Finally, you will need the usual personal information – name, age, address, social security number and contact numbers – and something to verify each one.

    Many loan applications are rejected because the borrower couldn’t provide documentation needed for approval. It’s important to assemble all necessary paperwork together before you start filling out the application.

    One more bit of advice: Shop around. It may feel you’re begging for help when you start the process, but the truth is, you’re the customer. If the lender wants your business, they will work with you to get a deal done. If not, keep shopping.

    Qualifying for a Loan

    Since most personal loans lack collateral, lenders will scrutinize your credit history, your income and your debt level before approving financing. Your credit history, and your credit rating, will help determine how much interest you’ll pay. The lower your credit score, the higher the interest rate and the less you’ll be able to borrow.

    Since there are many varieties of personal loans, there’s no single formula for qualifying to borrow. Payday lenders, for instance, will often loan money in anticipation of a paycheck or a tax refund. Payday lender often require a credit check, but might charge interest rates of 400% or more. The high interest can prove disastrous for borrowers, so be wary of such lenders and always consider the terms of the loan. Too many borrowers fail to understand how interest accrues and come to regret their decision.

    Some lenders will transact with people will low credit scores but will charge relatively high interest rates – often has much as 36%.

    As a rule, avoid payday lenders and carefully evaluate repayment terms and interest rates before borrowing. Personal loans can be cheaper than credit card balances and offer a way to consolidate several debts into one.

    Credit card debt is revolving debt while personal loans are installment debt. Credit rating agencies treat revolving and installment debt different, and transferring debt from revolving to installment can improve your credit score.

    How is My Credit Affected by a Personal Loan?

    If you are using a personal loan to consolidate and pay down credit card debt, you might discover that you credit score improves rapidly. A significant part of a credit score is based on credit utilization, which is the percentage of your credit in use. Since personal loans generally don’t involve a credit line, transferring debt from revolving credit card debt to the installment debt of a personal loan will lower your credit utilization amount, and that will have a favorable impact on your credit score.

    Personal loans can help you rebuild credit and pay off debt without the help of a debt consolidation firm. This can save you money, but it isn’t an option for everyone. If your credit score has dropped below 580 as the result of high amounts of revolving debt, it is unlikely you will be able to find a personal loan that makes financial sense. Before seeking a personal loan, it pays to know your credit score and find out what interest rates lenders charge. The lower your score, the higher your interest rate will be.

    If you think you’ll have a hard time making on-time payments on your loan, think twice about borrowing the money. Defaulting on a personal loan can severely damage you credit score if the default is reporting to one of the rating agencies. If you borrow the money from a family member and fail to repay, you might lose an important relationship and if you signed a contract, you could be sued. So always think ahead.

    Taking Out a Personal Loan: Banks vs. Credit Unions

    Banks and credit unions are the most common sources of personal loans. Both have positives and negatives, and it’s up to the borrower to decide which option is best.

    It’s important to know the difference between a bank and a credit union. Both banks and credit unions are publicly chartered, regulated institutions. Banks are for-profit businesses and credit unions aren’t. Shareholders own banks, but credit unions are owned by members, which credit unions call their account holders.

    Although banks have been a more accessible borrowing option in the past because of the large pools of capital they manage, credit unions are growing in popularity. Recently credit unions have become competitive with banks, offering lower fees and higher levels of service. In addition, membership in credit unions has become much less restrictive, making them available to a larger and more diverse population.

    Personal loans can be useful, but only if borrowers understand how they work and follow the rules for paying them back. When considering a personal loan, borrowers should consider the amount of interest they’ll pay and any difficulties they anticipate making payments. If your job is in jeopardy, it might not be a good time to take out a loan that requires uninterrupted payments.

    Personal Loan Scams

    If you have limited financial experience, or are a trusting soul, you could be a target for scam artists.

    Scam artists take advantage of the most vulnerable members of society, stealing millions of dollars every year from unsuspecting people who thought they were getting a good deal on a personal loan.

    If you aren’t experienced at borrowing money, be cautious at all times, whether you’re talking to a lending institution down the street or an online lender offering you a deal that seems too good to be true. It probably is.

    Here are things to watch for when you go looking for a personal loan, especially if you’re responding to an advertisement or to an online lender.

    • Advance payment fees. The lender will ask for a fee to review or process your loan. They may refer to it as an application fee, document fee or even an insurance fee, but legitimate lenders don’t ask for money in advance of giving you a loan. They disclose all fees and usually roll them into the cost of the loan.
    • Wire transfers. If the lender tells you to wire money for the fees he proposes, that is a problem. Verify the business name and a physical address for the lender to be sure it’s a legitimate business. Never wire money to an individual.
    • Guaranteed loan. There are some lenders who will call or send invitations to apply for a personal loan with a “guarantee” that you will be approved. Ignore them. The guarantees can’t happen until your credit score and financial situation have been evaluated.
    • Interest rate inflation. The interest rate for nearly every loan is determined by some combination of credit score, amount borrowed and repayment schedule. Inflating the interest rate by just a point and stretching the repayment schedule a few years can be very costly to borrowers.
    • Companies with copycat name. It is common, especially online, for scam artists to create a company name that sounds and looks familiar, but is a fraud. It is crucial to verify the business name and address before signing on with a company.
    • Personal information requests. Be careful not to give your date of birth, social security number, checking account number or any other important personal information unless you’re positive you’re dealing with a legitimate lender. Otherwise, you open yourself up to things like identity theft or having money stolen from your bank account.

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    Author

    Staff Writer

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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