The 5 Ws of Low-Interest Personal Loans
Whenever you want to borrow money, you want the lowest possible interest rate at the most convenient terms. The secret to finding a low-interest personal loan is simple — shop around. Make sure the lender explains the terms of the loan, including all fees and costs. However, low-interest personal loans are not easy to find. The lender is also going to ask tough questions and expects the best from you.
Here is a guide to low-interest personal loans, asking and answering for you the 5 Ws:
- What is a Low-Interest personal loan?
- Why Take a Personal Loan?
- How do You Qualify for a Low-Interest Unsecured Loan?
- Who offers and Where Can You Find Low-Interest Personal Loans?
- When to Take a Personal loan?
What is a Low-Interest Personal Loan?
We are all familiar with different types of loans, taken for all kinds of reasons, such as purchase a home, buy a car, pay for a wedding and pay off debt. To take out a loan, you have to show the lender that you have the means to pay it back, and the willingness to do so. Some loans only require your signature, your guarantee. Many loans, referred to as secured loans, require that you pledge an asset as collateral, for example, a mortgage loan or an auto loan. (Almost all loans have some form of personal guarantee, although there do exist non-recourse loans).
A loan agreement spells out the loan amount, interest rate, term, payment schedule, fees, early payment privileges, the general responsibilities of the borrower, and the lender's responsibilities. Loan agreements come in fine print, so make sure the loan officer clearly explains the contract in plain and clear language.
Personal loan: Lenders offer a personal loan to individuals (as opposed to businesses, corporations or other legal entities) as either a secured personal loan or an unsecured personal loan. The loan can be either an installment loan paid monthly over a specific period or a revolving line of credit. Charging purchases and paying bills on your credit card and then carrying over the balance is a common form of a personal loan.
Low-Interest rate: Interest rates are continuously fluctuating. 30 year fixed rate mortgages were under 4% at the beginning of 2012. On the other hand, credit cards carry a wide range of rates, with an average interest rate of about 14%. Personal loans also have wide fluctuations, going anywhere between 5% - 36%. Those interest rates are dwarfed compared to fees, especially those for people with bad credit. Payday loans and other similar personal loans have very high costs, and the annual interest rate can soar over 1000%.
Why Take a Personal Loan?
I recommend that you create a budget, a rainy day fund, and save money in an investment and retirement account. In the long run, proper planning saves you lots of money. However, even if you plan, there are many reasons to take out a personal loan, including emergency expenses (medical expenses, auto repair, significant one-off expenditures (a wedding, purchase of furniture or appliances), or education expenses. If you have a good reason to take out a personal loan, weigh your options carefully. Here are some questions to answer before looking for a low-interest personal loan:
- Do you own a home with equity? If so, maybe a cash-out mortgage loan or a HELOC (home equity loan or line of credit) is a cheaper option.
- Can you cut back expenses and save money? If so, instead of buying on credit, or taking out a loan, maybe you can save the money in advance, and then make the purchase.
How do You Qualify for a Low-Interest Personal Loan?
The two most important factors are your credit score and your debt to income ratio. Other factors include your employment and housing stability. The lender verifies your ability to pay and your willingness to pay.
Credit Score: The first thing a lender will check is your credit score. The most common score used is the FICO score, which is based on five main categories (the first two are the most important):
- Payment History: Do you make your payments on time? Late payments are detrimental to your score.
- Credit Utilization: Do you use all your available credit lines? It is advisable not to utilize more than 30% of available credit.
- Length of Credit History: Are your accounts new or have you maintained them for a long time? Instead of closing an account, use it sparingly. If your annual fees are high and you want to close accounts, do it progressively.
- Credit Mix: Do you have more than one type of credit? It is best to have different kinds of credit, mortgage, student loans, credit cards, auto loans
- New Credit: Are you taking out a lot of new credit at the same time? Stagger your new debt over time.
When lenders make a hard credit inquiry, your credit score drops, albeit by a small amount. Multiple credit pulls done for the same product during a 14-day period are only counted once, so shop around during that two-week period.
Debt to Income (DTI) ratio: Lenders analyze your employment situation and the stability of your income. Moving around from job to job decreases your chances of finding a low-interest unsecured loan. The same is true regarding housing, especially if you are paying rent. Lenders use a DTI ratio to determine if you can afford to take on new credit. DTI ratio consists of all mortgage-related payments or rent and all your recurring debt, based on actual payments, or minimum required payments. A general rule of thumb is that a DTI should not exceed 36%. The lower your DTI, the better.
Who Offers and Where Can You Find Low-Interest Personal Loans?
Traditional banks, credit unions, and peer-to-peer lenders offer personal loan. Some institutions only provide loans to their customers. Start by speaking to your local bank. Check if there are any unique offerings.
Here is an example from August 2018 of what the Santa Cruz Credit Union offers and requires for an unsecured personal debt consolidation loan:
- Terms vary depending on credit score.
- If you have a credit score over 740, the maximum amount available is $25,000, for a five year period, at 7.99%.
- If you have a low credit score, 625-654, then the maximum amount is $5,000, for three years, at 13.99%.
- You must provide proof of income for the past 30 days (pay stubs).
Shop around. Check lender Web sites to compare rates, and call lenders for current rates. Don’t turn in loan applications until you know what type of loan you want and the terms offered. Be very cautious with online or payday companies that advertise quick-and-easy personal loans. A sign of a loan scam is if you are asked to pay a fee to apply for a loan. If an offer sounds too good to be true, don’t take it. Deal with a lender you trust.
There are online lenders with good reputations, such as peer-to-peer lenders Prosper.com and Lendingclub.com. Both LendingClub and Prosper use your credit score as a large part of their decision whether to approve your loan and what interest rate you will get.
When to Take a Personal Loan?
Like any loan, only take one when you need it. Make sure you can afford to pay it back. Unsecured personal loans are not gifts, and default means that the lender will pursue you through all collection means available.
Before you consider taking a personal loan, consider these options:
- Save money for your big purchases. Plan and create an emergency rainy day fund, as well as a savings and investment account.
- Use collateral for a loan: Secured loans are cheaper than unsecured loans. When purchasing a home or an auto take out a purchase finance loan. If you have equity in your assets, then look into a cash-out refinance. Some banks offer low-interest personal loans against investment portfolios. Weigh the costs and benefits carefully.
- Use your credit cards wisely, and don’t run up big balances.
- Do a balance transfer with better terms than your current credit card. Make sure you don’t miss payments when transferring.
If you meet these conditions, then consider taking a low-interest personal loan:
- Have other debts, such as credit card debt, at a higher rate.
- Want to clear out your credit card balances into an installment plan, and you don’t have the discipline to optimize your payments.
- Have a specific purchase or emergency bill to pay. Make sure you can afford the loan payments.
Do not take out a personal loan to solve your debt problems. If you cannot afford or are struggling to make your payments on your loans and credit cards, then a personal loan is not the solution. It is just adding more weight on a load you cannot carry. If you don’t have good credit and can’t afford the payment, then a responsible lender will not offer you the loan. Even at their best, low-interest personal loans are no bargains. When you have bad credit, then they are expensive and dangerous.
Can't Find a Low-Interest Personal Loan?
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