Millions of Americans borrow personal loans to consolidate debt, cover unforeseen expenses, tackle home improvement projects and even start businesses. And even though it’s relatively easy to take out a personal loan, and a personal loan can be a solid way to get money quickly (see the latest personal loan rates here), it isn’t something that should be taken lightly and it can end up being costly for you. 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 fill out a loan application and show proof of your identity, address and income. The lender may ask for things like W2s, pay stubs, 1099s, bank statements, tax returns, utility bills, mortgage statements, driver’s license, passport and more.
While that may sound like a lot, the good news is that personal loans tend to fund pretty quickly. “Personal loans offer a quick and easy application process, especially compared to the lengthy, paperwork-filled 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 in a matter of minutes and if you’re approved, you can get the funds the next day,” says Ted Rossman, senior industry analyst at Bankrate. This guide will highlight how to get a personal loan.
2. Consider other options
“It’s essential to know the other options before getting a personal loan to be sure that it’s your most affordable option. In some cases, promotional credit cards or home equity financing could help you accomplish your goals and save you money,” says Annie Millerbernd, personal loan expert at NerdWallet. Indeed, rates on HELOCs and home equity loans tend to be lower than personal loans. This guide highlights the differences between a HELOC and home equity loan if you are thinking about one of those.
If you’re using a personal loan to repay debt, you may find that sometimes, a debt management plan offered by a reputable nonprofit credit counselor will include more attractive terms than a personal loan — especially if you have less than pristine credit. “Many people can qualify for something like a 5-year payback term with a 7% interest rate when consolidating higher-cost credit card debt,” says Rossman.
3. Know where to find the best rates
Online lenders — particularly fintechs — often offer the best rates, pros say. “But it makes sense to include some traditional banks and credit unions in your search, too. Rates vary so much that you should definitely shop around aggressively for the best terms,” says Rossman. (See the best personal loan interest rates you might qualify for here.)
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-qualifying doesn’t affect your credit score, you can shop around at multiple lenders before choosing one,” says Millerbernd.
4. Do some homework on the other fees you may incur
Look not just at the rate you’ll be charged, but also at the fees. For example, many personal loans include an origination fee, which typically ranges from 1% to 8%. “This is something you should incorporate into your research process as you shop around. Also, origination fees are usually deducted from the loan amount, so if you need $10,000, but there’s a 8% origination fee, you really need to ask for close to $11,000,” says Rossman.
5. Understand how personal loans work
A personal loan is a loan issued by an online lender, bank, or credit union, usually in an amount ranging from about $1,000 to $100,000; you usually repay them at regular intervals, such as each month, over anywhere from one to seven years.
Personal loans are usually unsecured debt, so you typically don’t have to directly put an asset such as your home or car on the line as collateral. You will get the money in one lump sum, and lenders typically aren’t that strict about what you can use the money for. Just note, if you don’t pay back the loan, you will damage your credit score.
That said, if you’re having trouble paying your personal loan, there are instances where you can take out an additional loan to help pay off the old one. “It can make sense if you can lower your interest rate, but be mindful of fees to originate the new loan,” says Rossman.
6. It’s unlikely you’ll get hit with a tax bill around your personal loan
“Typically there aren’t any tax implications when taking out a personal loan because it’s not considered income. If you end up getting part of the loan forgiven or canceled, only then does that amount become taxable as income,” says Matt Schulz, chief credit analyst at LendingTree.