Perhaps you’re looking to make some large-scale renovations to your home. Maybe you’re trying to fund a major life event, like a wedding. Or perhaps you’re looking for a way to consolidate high-interest credit card debt.
Whatever the circumstances, you need money. But how do you get it? Do you open up another credit card? Do you take out a home equity loan?
The easier and often less expensive method would be to take out a personal loan . But what exactly is a personal loan? And how is it any different from traditional loans?
You might have a million questions running through your head. Luckily, we reached out to the experts at RocketLoans to answer these 10 frequently asked questions about personal loans.
What Is a Personal Loan?
Also known as an “unsecured loan,” a personal loan isn’t backed by collateral like a mortgage or car loan. Because there’s no asset to use as collateral, like a house or an automobile, personal loans tend to have high monthly payments compared to credit cards.
They’re typically borrowed from a bank, credit union or online lender and are payed back in equal monthly payments with a fixed interest rate.
Unlike credit cards, which have no fixed payment terms and tend to have high interest rates, personal loans have a fixed payment term and often have lower interest rates, depending on your credit score and other financial factors.
What Is a Personal Loan Used For?
“Personal loans can be used for debt consolidation, home improvement, auto expenses, medical expenses, credit card payoff, small businesses, large purchases or anything else that life may throw at you,” says Bill Parker, CEO of RocketLoans.
However, the most common personal loan uses are to consolidate high-interest credit card debt. Often when you take out a personal loan, you’re able to reduce your monthly payments and potentially save on interest because the monthly payment and interest rate for a personal loan is fixed, rather than revolving like a credit card.
How Do I Qualify for a Personal Loan?
Much like traditional loans, qualifying for a personal loan is largely determined by your credit profile, income, other debt obligations and monthly cash flow.
While each lender varies, they typically look for a minimum acceptable credit score that falls within a range of 600 to 700+. Not surprisingly, a lower credit score will receive higher interest rates and monthly payments, which can be more difficult to pay back.
Will Getting Prequalified for a Personal Loan Affect My Credit Score?
Much like looking for the right mortgage lender for you, you’ll want to compare and contrast rates from multiple personal loan lenders before locking in your choice.
Most lenders will allow you to see estimated rates without affecting your credit score. That way, you’re able to view and compare several rate options at once without impacting your score.
This is referred to as a “soft inquiry,” a method that lenders may use to verify your identity and assets and potential financial risks. In other words, if you’re just “window shopping” for a lender; you don’t have to worry about affecting your score.
What Documents Are Needed for a Personal Loan?
When you find a lender that works for you, there are a few documents you’ll need during the application:
Your Social Security card or another form of identification
Your W-2 forms, pay stubs, bank statements or tax returns
Each lender may require different documents based on your personal financial situation, but the three items above are standard for most lenders.
What Is a Personal Loan with Collateral?
Most personal loans are unsecured, meaning they aren’t backed by collateral, like a house or car. Your ability to get a personal loan is based solely on your financial history, like your credit profile.
If you don’t have a credit score that’s between the 600 and 700+ range that most personal lenders look for, some lenders might offer you a secured personal loan, also known as a collateral loan.
Just as you might assume, this allows you to offer some form of collateral, like a vehicle or savings account, in order to receive a personal loan. By offering collateral, you will be able to receive a personal loan with a lower rate or larger loan amount, depending on your situation.
However, like most traditional loans, if you make a late payment, the lender might take the asset you used as collateral.
How Much Can I Borrow and How Long Can I Borrow?
Depending on the lender and your personal financial situation, personal loans can average between $5,000 and $15,000, with a maximum of $35,000 and terms between 24 and 60 months.
A personal loan will have a monthly payment and end date with interest rates that vary by lender. The higher your credit score and income, the more money you can potentially borrow.
Unlike credit cards, personal loans are a one-time loan with a fixed dollar amount that will be borrowed. In other words, there’s no revolving balance like a credit card, so once you pay off the loan, the account is closed.
Can Pay Back My Loan Early Without Penalties?
There’s a set period of time to repay your personal loan, which is stated in months and determined by the lender. Based on the length of your repayment period, your monthly balance and interest rate will vary.
For example, personal loans with longer repayment periods will have a lower monthly balance and a higher interest rate, meaning you’ll pay more in interest over the life of the repayment period compared to loans with shorter repayment periods.
Not all lenders are the same, and some might have a prepayment penalty that charges a fee for paying off your loan early.
Why Is My Personal Loan Interest Rate Higher Than My Mortgage or Auto Loan Interest Rate?
Unlike like a mortgage or car loan, personal loans aren’t backed by collateral and are therefore considered unsecured loans.
In other words, a secured loan on a mortgage or car loan is backed by the actual asset – in this case, the home or car, respectively. Therefore, if you fail to make payments and default, there is a possibility you may lose the asset.
It’s for this reason that unsecured loans have higher interest rates: They create a higher risk for the lender. Much like other loans, however, you still pay back the loan in fixed monthly payments with interest since it’s money borrowed from a bank, credit union or lender.
“It’s important to remember that even with a higher interest rate, the total cost of a personal loan (Finance Charge) can be significantly lower than borrowing from a home because the term is significantly shorter,” Parker adds.
What Is an Origination Fee, and How Much Is It?
“An origination fee is a fee that covers the cost of processing a loan, and it’s charged upfront,” Parker explains. “Like all other loans, the amount of the origination fee varies from lender to lender.”
An origination fee can range from 1% to 6% depending on the lender and, like your interest rate, is based on your credit and length of the loan. Like the interest rate, the higher the credit score, the lower the origination fee.
For this reason, make sure you borrow enough money for the loan amount you need and enough to cover the origination fee.
“RocketLoans origination fees range from 1% to 6% of the loan amount, and they are deducted from the loan before the funds are distributed to your bank account,” says Parker. “Some lenders do not charge an origination fee and instead raise the interest rate to account for the cost of processing a loan.”
There are a lot of things to consider before you apply for a personal loan. The most important, however, is making sure you don’t borrow more than you can pay back.
If you’re ready to apply for a personal loan, talk to an expert at RocketLoans today about your goals for taking out the loan and to see how much you qualify for.
Do you have any questions about personal loans that we missed? Let us know in the comments below!
The post 10 Answers to Frequently Asked Questions About Personal Loans appeared first on ZING Blog by Quicken Loans .