According to TransUnion, one of the largest credit bureaus in the country, personal loans accounted for roughly $148 billion in consumer debt at the end of 2020. You may be wondering why so many Americans are taking out thousands of dollars on personal loans each year.
Personal loans or any type of loan for that matter can be used to your advantage, or it can severely harm your finances if mismanaged. Personal loans can be a helpful tool when it comes to your finances, often in ways that you might not expect.
What Are Personal Loans?
Most personal loans out there are unsecured, meaning they do not require any type of collateral. So instead of relying on your assets (such as a car or home), lenders approve you for a loan based on your creditworthiness.
Once you are approved for a personal loan, you agree to pay back the money you owe in fixed monthly payments over the course of the loan’s life. The length of the loan varies but oftentimes will fall somewhere between two and seven years.
As previously mentioned, personal loans are granted based on your creditworthiness. If you have good credit, you will most likely be offered a low-interest personal loan. On the other hand, if you have credit that needs some work, your interest rates will not be as good.
If your credit is in poor shape, it may be difficult to get a personal loan. With that being said, not all hope is lost. There are several options later discussed in this article that are suitable for those with a low credit score.
Advantages to Using a Personal Loan
Personal loans are great because, unlike auto or home loans, they aren’t required to be used for one specific purpose. Once you’re approved for a personal loan, the money is then wired into your bank account and is free to use for whatever purpose you have in mind. Here are a few instances where using a personal loan may help your financial situation:
1. Debt Consolidation
One of the most popular reasons people get personal loans is to help consolidate their debt. It may seem a bit strange to borrow more money to pay off the debt you already have, but in a lot of cases, it can save you time and money.
You basically use the money that you get from the loan to pay off other loans and all of your credit cards. This allows you to combine all of those balances into one payment. Plus, if you have a lower interest rate on the personal loan than on your credit cards, it could save you a pile of money in interest. If you have some high-interest debt sources, personal loans could be a great option to consider.
2. Moving Expenses
Another popular reason that people use personal loans is to cover moving expenses. Moves can cost thousands of dollars, especially if you are moving a long distance.
You might not have enough money to cover the costs of transporting your belongings, getting new furniture, and paying your first and last month’s rent in a new place. A personal loan can help to make those expenses easier to handle if you can’t afford them all upfront.
3. Financing a Vehicle
Yes, auto loans do exist, but in some cases, you might find it more difficult to get an auto loan with a good rate. You can also use a personal loan to buy the vehicle outright instead of making monthly payments on an auto loan. This is particularly helpful when it comes to buying used vehicles being sold by the owner rather than through a dealership.
Personal Loans vs. Other Types of Loans
So, what makes personal loans so special when there are so many other types of loans out there? Other loan options are not always the best choice and can sometimes be more of a problem than they are worth. Here are a few comparisons.
Personal Loans vs. Car Title Loans
Car title loans tend to be approved fast and are relatively easy to get as long as you have a vehicle. However, car title loans require that you offer your car up as collateral. If you aren’t able to pay back the loan on time, the lender will repossess your vehicle and sell it, keeping the profit.
A personal loan may be a better option since most of them would not require you to provide the lender with collateral. While it may be more difficult to qualify for a personal loan, it’s still worth a shot considering you would not have to worry about losing your vehicle if something goes wrong.
Personal Loans vs. Payday Loans
Oftentimes people who find that they need some extra money over the course of a month will consider getting a payday loan. Payday loans are short-term loans and allow the borrower to receive the funds fast. Payday loans may be short-term fixes, but they come with a lot of downsides. They have obscenely high interest rates, which can make them a bad financial decision.
Personal loans are always going to be the better option when comparing them to payday loans. They have much better interest rates and you’re able to borrow more and pay it back over time. If you’re able to wait until a bank or credit union makes a decision on your personal loan, you will be much better off than if you resorted to a payday loan.
Why You Should Never, Ever, Get a Payday Loan
If the last section wasn’t convincing enough, here’s some more insight on why payday loans are never a good idea. You’ve probably seen a billboard or advertisement for payday lending, mentioning that it is a fast and easy way to get money.
Well, if something seems too good to be true, it most likely is too good to be true. Yes, payday lending can get you a couple hundred dollars quickly, but there are so many negatives to payday loans that make them a horrible option. Here’s a look into what you’d be signing up for.
How Do Payday Loans Work?
Payday loans are available through certain brick and mortar lenders, as well as online lenders. They can be hard to repay, and they could end up costing far more than you realize.
If you were to get one of these loans, you would need to provide the lender with proof of income, as well as authorized post-dated checks that coincide with the dates when you receive a direct deposit from your employer. You basically borrow a few hundred dollars and give the lender access to take the money you borrowed plus interest from you on your next payday.
While this may sound simple enough, payday loans are a horrible option. The interest rates on these loans can be through the roof. On average, payday borrowers pay $520 in fees just to borrow $375! What you think may be a good idea could very well be a bad one.
Why Do People Use Payday Loans?
Most people who resort to payday loans are using the money to pay for regular recurring expenses such as rent payments or utility bills. The average income of payday loan borrowers is $30,000 annually.
If you’re in a position where you’re strapped for cash, do everything in your power to avoid payday loans. They may provide you with temporary relief, but the long-term damage is crucial and can land you in an even worse position financially.
Alternatives to Payday Loans
While those who would normally rely on payday loans will not likely qualify for traditional loans or credit, there are still a few other options to consider. Here are three of them:
1. Talk With Your Lenders Directly
This is one of the first things you’ll want to do when you are potentially getting close to being late on making payments to your creditors.
You can talk with them about setting up a payment plan with installments. You could also ask for an extension on the due date. Lenders are often willing to work with you because they would rather opt for some type of arrangement than wait for you to default on the loan.
2. See If You Can Get an Advance at Work
This may not be possible for everyone in all types of job fields, but it can be worth talking about with your employer. Rather than taking out a loan, you’re requesting an advance on your pay that could help you out in the short term. There are no fees associated with an advance, so you don’t have to worry about paying extra.
3. Borrow From Family or Friends
In some cases, you might want to ask some family or friends to help you out with a short-term loan that will cover the costs of the expense. It may damage your pride a bit, but it’s better than taking out a payday loan that has sky-high interest rates.
Have Bad Credit? Try Out a Credit Builder Loan
If you don’t qualify for a traditional personal loan due to less-than-perfect credit, a credit builder loan may be a fantastic way for you to repair your credit. These loans take some time and discipline, but they can greatly improve your financial situation.
What Are Credit Builder Loans?
Credit builder loans are a type of loan where the bank holds onto the money borrowed while you make payments on it, thus, building your credit in the process. Once you pay off the loan, the money is then transferred into your bank account.
Typically, these loans are a great option for those who are in need of credit repair or those who are just starting to build their credit. They vary in their amounts but are generally between $500 and $1,500.
How Credit Builder Loans Help You Build Credit
So how do credit builder loans help you, exactly? When you take out one of these loans, the lender will report your payment history to the three credit bureaus each month. As long as you pay on time each month, your credit reports will reflect a positive payment history.
To put it in perspective, your payment history accounts for 35% of your overall FICO score, making it the most important factor that affects your credit score. The longer you pay on time, the healthier your credit report will look.
Personal loans can be a great option if you use them correctly. They can provide you with financial relief and allow you to build your credit score. Often they will come with lower interest rates than credit cards or other types of loans.
When you apply for a personal loan, be realistic with your ability to pay it back. Shop around for the best offer and do everything in your power to stay on top of the monthly payments. With time and consistency, your finances can change for the better!