Should You Apply for a Personal Loan?

A personal loan is an extension of credit from a lender, that is typically classified as an “unsecured loan”. Although, in rare instances, personal loans may also be secured to collateral. Personal loans differ from credit cards in that they are not “revolving lines of credit”, they are an extension of credit that is re-payed in installments and has a set amortization period. They differ from auto loans in that auto loans will always be secured to collateral (in this case the automobile), however both are paid back in installment payments.

What Factors Are Most Important When Applying for a Personal Loan?

The two most important factors (by a long shot) are a consumer’s DTI and credit worthiness. A consumer’s Debt to Income ratio is the percentage/ratio of their income that is allocated towards debt obligations (i.e. mortgages, auto loans, credit card payments, student loans, etc.). If your income is $10,000 per month and you spend $2,000 on a mortgage and $2,000 on all other obligations (obligations reported to credit bureaus are the only ones that matter in this scenario), then your DTI is 40%. In general, lenders want to lend to individuals that have less debt on their books. This is especially the case with unsecured loans like a personal loan, so the less debt you have on your books, the better

The second factor is your credit score and subsequently your overall credit worthiness. Better terms will always go to individuals that are more credit worthy and have better credit scores/reports. This includes making timely payments, having a good utilization rate (this is often overlooked, this accounts for 30% of your score), having a diverse credit portfolio and good mix of credit, the length of time your accounts have been established, etc. Along the same vein, lenders want to see that you have successfully completed repayment of other debt obligations and loan products. Lenders always use past data to help them decide if you are good credit risk or not.

What Else is Important for Qualification

These are the most significant financial requirements, otherwise lenders will typically want to view pay stubs, proof of employment, government identification, etc.

When Does it Make Sense to Take Out a Personal Loan?

It makes sense to get an unsecured loan if it’s an improvement upon your current interest rates on any debt obligations and if you are consolidating higher interest debts with the unsecured loan and need an influx of cash in the short term. Many make the mistake of taking out a personal loan (with seemingly good terms) only to find out that maintaining the high monthly payments is not something that fits into their budget. To prevent this, perform an income and expense evaluation and make sure it’s something you can definitely afford in the short term.

A personal loan can is meant to be used for literally “anything that is personal”. So, in this regard, personal loans can really be used for anything.

However, the most common reasons consumers take out personal loans are as follows:

A. Debt consolidation (consolidating unsecured debt into a personal loan with a better APR). This is a very popular reason to get a personal loan, to save money on interest payments.
B. Wedding Expenses – This is a big one and many times newlyweds need the extra funds to finance some of the wedding costs. If they’re coming up short on their wedding some use a personal loan to fill in the gaps.
C. Home Remodeling/Renovations – This has been a popular one as of late. Americans pour a tremendous amount of money into remodeling each and every year. Due to this they have begun remodeling their home with the help of personal loans. This can include buying new furniture, appliances, flooring, carpets, etc. This type of remodeling and spending isn’t just limited to structural changes.
D. Moving Costs – If you are one of the many people moving you might consider taking out a personal loan to finance the expense of moving. Moving can often times be expensive depending on where you are going so many consumers opt to use a personal loan if they are short on funds.
E. Medical/Emergency Expenses – Although it’s unfortunate, in many cases, consumers might consider taking out a personal loan to finance emergency expenses whenever “life happens”. This can include unexpected medical expenses/hospital bills, breakdown of an automobile, etc.

There are numerous reasons you might apply for a personal loan. For many consumers the options are typically limitless but you shouldn’t be applying for a loan for funding that you simply do not need. Make sure you absolutely need the loan you are applying for since loans are not revolving lines of a credit and you don’t want to end up paying interest on cash you never really needed to borrow in the first place.