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 Rocket Loans to answer these 10 frequently asked questions about personal loans.
What Is a Personal Loan?
A personal loan is an unsecured installment loan. Unsecured simply means the loan is not backed by collateral such as a home, boat or car. They’re typically available from a bank, credit union or online lender and like other installment loans are paid back in equal monthly payments with a fixed interest rate.
Unlike credit cards, which tend to have high interest rates, personal loans have a fixed repayment term so often have lower interest rates, especially if you have good credit.
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 Rocket Loans.
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 lower your interest rate, make one monthly fixed payment and save on interest by paying your debt off sooner.
How Do I Qualify for a Personal Loan?
Since there is no collateral, qualifying for a personal loan is ultimately determined by your credit history, 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+..
At Rocket Loans, for example, you must have a minimum credit score of 640, and not surprisingly, the higher your credit score the more likely you are to receive lower rates,” said Parker.
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 offers from multiple personal loan lenders before locking in your choice.
Most lenders perform a “soft” credit inquiry to show you prequalified offers. This allows you to compare each lender’s offerings without affecting your credit score.
What Documents Are Needed for a Personal Loan?
The main reason lenders ask for documentation is to help verify your identity and income. When documentation is needed, typically you’ll be asked to provide:
- Driver’s license or another form of identification
- Pay stubs and/or bank statements
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 and income.
Some lenders offer a personal loan with collateral, also known as a collateral loan, when your credit history and income do not meet their minimum requirements. By offering collateral, you may be able to receive a personal loan with a lower rate or larger loan amount, depending on your situation.
How Much Can I Borrow and How Long Can I Borrow?
Depending on the lender and your personal financial situation, personal loans typically range between $5,000 and $15,000, with a maximum of $45,000 and repayment terms between 24 and 60 months. The higher your credit score and income, the more money you can potentially borrow.
Can I Pay Back My Loan Early Without Penalties?
When selecting your personal loan you will also choose a repayment period, typically in months. Should you choose to pay off your loan early, it’s important to note whether your lender charges a prepayment penalty fee.
“At Rocket Loans you will never be charged a penalty or additional fees for paying back your personal loan early,” Parker added.
Why Is My Personal Loan Interest Rate Higher Than My Mortgage or Auto Loan Interest Rate?
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, you are at risk of losing the asset.
On the other hand, an unsecured personal loan has no collateral so the lender assumes the risk on your promise to repay.
It’s for this reason that unsecured loans have higher interest rates: They create a higher risk for the 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.”
“Rocket Loans 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.”
For this reason, make sure you borrow enough money for the loan amount you need and enough to cover the origination fee.
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 Rocket Loans 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!
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