For the right consumers, personal loans can be a quick way to get much-needed cash for anything from a home repair to a college tuition. With the right qualifications, you can be approved for a personal loan in the morning and have the cash deposited into your account in as little as one day depending on the lender.
While applying is easy, qualifying for a personal loan may be more difficult. Here’s what you need to know about personal loans and how to get approved for one.
What is a personal loan?
A personal loan allows a consumer to borrow a lump sum of money for personal use and pay it back in fixed monthly payments over a set amount of time.
One significant difference between unsecured personal loans and other types of loans is that they don’t require collateral. When you buy a car, for example, the car serves as collateral and the lender can repossess it if you fall behind on your mortgage payments. To get an unsecured personal loan, you just have to qualify.
Personal loans come in a wide range of amounts and interest rates. The terms of personal loans vary by lender and range from six months to 84 months as of Feb. 2, 2018. They can be for as little as $2,000 and as much as $100,000, although the majority of personal loans are for much less. Best Eggs’ loans average between $13,000 and $14,000, according to Bobby Ritterbeck, chief marketing officer for the company.
What are personal loans used for?
Unlike a mortgage, which is a loan for a house, or an auto loan, which must be spent on a vehicle, personal loans can be used for almost anything.
“People use it for a ton of reasons, from home repairs to medical [expenses] to all kinds of major purchases,” Ritterbeck said. People most commonly take out personal loans, however, for debt consolidation. In this process, borrowers use a personal loan to pay off other high-interest debts, which can simplify and reduce their monthly debt payments.
Alia Dudum, millennial money expert at LendingClub, said that LendingClub encourages anyone who needs credit to think about personal loans as “a responsible way to pay for something expensive,” whether the expense is planned or unexpected.
“You can’t always control when you have a major expense, but you can make good decisions,” she said. LendingClub’s borrowers primarily use personal loans to pay off high-interest debt, unexpected expenses such as medical bills or car repairs or a planned expense such as a vacation or home remodel.
How do I qualify for a personal loan?
Most lenders will look at two factors when you apply for unsecured personal loans: your credit history and your ability to repay the loan. Borrowers don’t have to provide collateral, such as a house or car to back their loan, nor do they need a cosigner (unless a cosigner is needed to strengthen your odds of getting approved).
Instead, lenders will look at your personal credit history and other factors, such as your income.
“That makes it easier for us to provide you quicker and easier access to your loan in comparison, to say, a mortgage loan that requires an appraisal of your home,” Dudum said.
Here’s a breakdown of how lenders determine whether you qualify for a loan.
Each lender will determine its minimum credit score for receiving a personal loan, and some are more lenient than others regarding what scores they will accept. For Best Egg, for example, the average credit score for qualified applicants is 710. Ritterbeck said that most conservative financial institutions are comfortable issuing personal loans to applicants with scores around 680 and above.
Your credit score matters because it is a reflection of your ability to repay a loan. The score is compiled from information gleaned about how you handle credit, which could include:
- Types of credit or loans you’ve carried (revolving, like credit, or non-revolving, like a mortgage)
- The amount of each loan or the credit limit for each credit card you own vs. how much of that balance you are using from month to month
- Whether you paid on time
- Collections activity, bankruptcies, foreclosures or other negative marks
There are three federal credit reporting agencies that compete to compile American consumers’ credit histories: Equifax, Experian and Transunion. While each agency collects about the same information on each consumer, their credit score calculations may differ because the agency may not have collected the exact same information or it may store or display the information differently than the other agencies.
It’s important to note that your credit score will change over time as credit reporting agencies collect more information and tweak their calculation models. That means your score could be different from one month to the next.
Get your credit report and score for free
Each of the three reporting agencies will provide one free credit report a year, which you can get by visiting AnnualCreditReport.com or calling 1-877-322-8228.
There are lots of ways to get your credit score or credit score estimate for free these days. The Discover Scorecard, for example, offers a free FICO score.
Here’s our guide on getting your free credit score >
How to improve your credit score to get better loan terms
First, look for errors on your credit report, where you may find information that is inaccurate or wrong. If you find errors that could have lowered your credit score, dispute the error with the appropriate credit bureau. Check all three reports.
Then, take a look at your financial situation and make some changes.
- Lower your debt: Stop spending on credit cards and come up with a strategy for paying down your balances.
- Pay your bills on time: As much as 35 percent of your credit score could be based on your payment history, so make sure you pay all of your bills on time. If you are forgetful, set up automatic payments or monthly reminders.
- Don’t close your unused credit card accounts: Unless your credit cards carry expensive annual fees, there’s no real benefit to closing them even if you aren't using them. Your credit score will take into account the average length of time you’ve been using credit, so holding an account for a long time could actually benefit your score.
- Don’t open new credit: As you rein back your spending, avoid the temptation to apply for more credit cards. Lenders may consider you risky if you open a lot of new accounts in a short amount of time.
The length of time it takes to improve your credit score depends on why your credit score is low in the first place. In any case, the personal financial discipline you develop as you work to improve your score will leave you with better spending and saving habits.
Debt-to-income ratio (DTI)
Your DTI is the amount of monthly debt obligations you have, including credit card payments, auto loans and student loans, divided by your monthly gross income. The calculation shows lenders the percentage of your income that you use to pay off debts.
“Lenders see this as an indicator of your ability to comfortably take on and pay off more debt,” Dudum said.
Wells Fargo lists a DTI of 35 percent as “looking good” and indicating that your debt is manageable in relation to your income, and that you likely have spending money left over after you pay your bills.
If you have a DTI between 36 and 49 percent, you may want to improve your financial situation so that you are in better shape to handle extra expenses. If your DTI is in this range, lenders
may look at additional eligibility criteria, like your income or whether you have a cosigner.
Credit utilization rate: This rate is calculated by dividing how much credit you’re using (the statement balance for each of your accounts) by the amount of credit you have
access to. “If it’s higher than about 30 percent, many financial companies see this as an indicator that you might not be as responsible as you could be,” Dudum said.
Credit history: How you’ve managed debt in the past can be a good determinant for how likely you are to pay back a personal loan. That means if you have little or no credit history, lenders may not approve your personal loan application.
“If you don’t have a track record with credit, it’s difficult for lenders to guess how you might handle paying your debts,” Dudum said.
Cosigner: If you have trouble meeting personal loan requirements, which could happen if you have a low credit score, no credit history or a bankruptcy in your past, you may need a cosigner.
Typically, cosigners are trusted friends or family members with good credit who will agree to take responsibility for the loan if you can’t make the payments. Lenders will factor in your cosigner’s credit history and credit score rather than yours when determining whether you qualify for the loan, which will up your chances of qualifying and securing a good interest rate.
Proceed with caution when considering a cosigner. If you don’t make your loan payments, you could ruin your cosigner’s credit history, stick them with the balance of the loan, and wreck your relationship with your cosigner.
How to apply for a personal loan
The application process for an unsecured personal loan is simple and fast.
“The old way is you’d walk into your local bank, wait in line to speak with a loan officer and apply that way,” Ritterbeck said. “In a lot of cases today you can still do that, but you also can go online, and in some cases call, and get a decision in a couple of minutes of what options are available to you.”
Online lending platforms will first ask you to fill out an application to check your credit rate. The personal loan industry can often show you your personal loan options without running a “hard” credit inquiry that would impact your credit score. These are typically called pre-approvals or prequalification checks but they aren’t final. When you are ready to apply for the loan, it will result in a hard credit inquiry. You may be able to get free quotes from LendingTree’s personal loan marketplace by filling out a short online form. LendingTree is the parent company of MagnifyMoney.
After you receive options for a personal loan, including the amount you qualify for and the interest rate, you can choose one to apply. “Generally speaking, the better your credit profile, the lower the rate of interest you’ll be charged in exchange for borrowing,” Dudum said. “That said, there are many other factors we take into consideration. One number couldn’t tell your whole financial story.”
Interest rates vary, but they can be as high as each state allows. OneMain, for example, can offer interest rates as high as almost 36% on personal loans, and Best Egg’s highest rate is 29.99%.
Once you decide which loan to apply for, you’ll need to submit proof of employment and income, such as a pay stub, said Kim Wijkstrom, chief marketing officer for OneMain Financial. Decisions on the loan can come within the hour, and the money could be deposited in your account the same day.
Lenders with alternative qualifications
Not all lenders follow the typical formula for personal loan requirements. OneMain, for example, uses credit scores as a guideline that gives a picture of a consumer’s credit history and focuses more on the applicant’s income and debt obligations, Wijkstrom said.
Here are others:
SoFi: SoFi is strict about approvals, as it prefers applicants with a good job and a history of on-time payments. It also does not allow cosigners or joint applicants. SoFi is unique in that it does not charge origination fees and has additional perks like loan forbearance if a borrower loses a job through no fault of his or her own. Interest will continue to accrue and is added to the loan balance, and SoFi will not report your payments to a credit bureau as being overdue.
Read our review of SoFi here.
Upstart: While Upstart initially focused on helping graduate students with significant debt, it now also offers loans to consumers with a strong credit history. Upstart’s formula for calculating approval is unique and considers an applicant’s career, education, job history and standardized test scores.
Read our review of Upstart here.
Earnest: Unlike most lenders, Earnest uses a merit-based system for determining who qualifies for a loan. Recent graduates and others who are starting to build credit history may qualify for these loans, which offer some of the most flexible terms along with customized loan and repayment plans.
What if you are rejected for a personal loan?
You may not qualify for a personal loan the first time you apply, but it is possible to improve your financial position and successfully qualify later.
“People are of course usually very disappointed if they don’t get a loan, and the first thing to address is the emotional response,” Wijkstrom said. “Don’t be defeated when rejected.”
At OneMain, financial advisers will talk with clients about why they were not approved and what they can change. Sometimes that means fixing their credit history, such as paying bills on time for a set period. Others may find errors on their credit report that hurt their chances of qualifying for a personal loan.
You may also want to look into other options for credit, such as equity in your home that could help you get a different kind of loan, Ritterbeck said.
When used wisely, personal loans can help you get out of debt and manage large expenses. Regardless of when you need a personal loan, it’s never too early to integrate good habits into your financial life to ensure that when you do apply for a personal loan, you will qualify for the amount you need.
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