When you take out a personal loan, you receive a lump sum that you repay over time with interest. Personal loans usually have lower interest rates than credit cards, making them a more cost-effective option for larger expenses. Loan terms typically range from 1 to 7 years, though some lenders may offer longer terms. Longer terms lower your monthly payments but increase total interest costs, while shorter terms result in higher monthly payments but less overall interest.
Interest and Fees
In addition to interest, some personal loans come with an upfront fee known as an origination or administrative fee. This fee typically ranges from 0% to 12% of the loan amount, depending on the lender and your credit profile. Key points about origination fees include:
- They are often deducted from the loan amount at disbursement.
- The fee is included in the loan’s APR, so comparing APRs rather than just interest rates is essential.
- A higher credit score may help you avoid origination fees.
Late payments or insufficient funds may result in late or NSF fees. However, some lenders, like SoFi, do not charge late or origination fees.
Eligibility for a Personal Loan
Lenders assess your credit history, income, debt-to-income ratio (DTI), and employment status to determine eligibility. DTI compares your existing monthly debts (e.g., credit cards, auto loans) to your gross monthly income.
Before applying, consider prequalifying. Prequalification gives you an estimate of loan options and rates without a formal application and doesn't affect your credit score. To prequalify, you'll usually need to provide basic information such as your name, contact details, loan purpose, loan amount, and sometimes your Social Security number.
Keep in mind that proceeding with a full application results in a hard credit inquiry, which may lower your credit score by a few points for up to a year.
Bad-Credit Loans
For borrowers with bad or no credit, loans designed for bad credit can be easier to secure. However, they typically come with higher APRs. If the interest is too high, consider adding a cosigner to reduce the cost.
Be cautious of predatory loans like payday loans, which often have extremely high APRs—sometimes exceeding 400%. Payday loans generally charge $10 to $30 for every $100 borrowed, with short repayment terms (two to four weeks) and loan amounts up to $500.
The problem with payday loans is their short repayment period, which can make it difficult to pay on time if you're already struggling financially. This can lead to rollovers or renewals, adding more fees and making the loan much more expensive over time.
A safer alternative is a payday alternative loan (PAL), offered by some federal credit unions. PALs provide loan amounts up to $2,000 with APRs capped at 28%. Some credit unions offer these loans to new members even after joining.