Secured and unsecured personal loans
An unsecured personal loan is money borrowed on the strength of your credit score. A secured loan, meanwhile, requires that you put something of value up as collateral. The personal loan interest rate on a secured loan tends to be lower because the lender knows that if you miss payments, it can take possession of whatever you put up as collateral (like a car or house), sell it, and recoup their loss.
The benefit of secured personal loans is the lower interest rate, making loan repayment easier for you. The disadvantage is that the lender has the legal right to repossess whatever you put up as collateral if you miss payments.
How can I use a personal loan?
Once you are approved for a personal loan, most lenders do not care how you spend the money. You may decide to use it to:
However, there are lenders that specialize in specific types of loans, and your loan proceeds must be used in a certain way. For example, some lenders offer a debt consolidation loan that can only be used to consolidate debt.
How high does my credit score need to be?
If you're ready to take out a personal loan, it's natural to wonder if your credit score is high enough. The truth is, there are personal loans available for a wide range of credit scores. Unless you have very bad credit, there's a good chance a lender somewhere will be willing to work with you. The rub is, personal loans for borrowers with poor credit usually carry a higher interest rate and loan fees.
Loan fees
As it stands, borrowers with the highest credit scores tend to land loans with low interest rates and low fees. No matter your credit score, here's a list of fees to watch out for.
Application fee
When you submit your application, before you get a decision, you may be required to pay an application fee of $25 to $50. Lenders say they collect an application fee to cover the administrative cost of processing your application. That includes getting a copy of your credit report and reviewing the details of your request.
Not every lender charges an application fee, so be sure to look for one that does not. Again, the higher your credit score, the better your chance of being allowed to skip the application fee.
That's because lenders understand that they are competing for borrowers with solid credit, and they do not want to discourage you from applying.
Origination fee
A common loan expense -- particularly among those with lower credit scores -- is an origination fee. An origination fee can run from anywhere from 1% to 8% of the amount borrowed.
Let's say you take out a $10,000 loan with an origination fee of 4%. That means the fee will be $400. Typically, origination fees are deducted from loan proceeds before those proceeds are deposited into your checking account. So instead of receiving the entire $10,000, you would receive $9,600. And even though you didn't receive the full $10,000, you're still expected to pay it off as though it was part of your proceeds.
Some lenders have chosen to nix the origination fee to lure borrowers with solid credit scores. No matter your credit score, shop around for a lender that does not charge this fee. After all, there is no reason to pay interest on money you never received.
Prepayment penalty
Of all the fees charged by lenders, a prepayment penalty is probably the least common. If you do happen to get saddled with a prepayment penalty, it means that you are required to pay a fee if you pay a loan off faster than was scheduled. In other words, if you pay a five-year loan off in three years, the lender will require you to pay a prepayment penalty.
The rationale behind a prepayment penalty is that the lender counts on earning a particular amount of money from interest paid. When you pay a personal loan off early, the lender earns less interest. In an attempt to make up for that lost interest, it tacks on a prepayment penalty.
As mentioned, the prepayment penalty is one of the least common fees charged by lenders (and is sometimes referred to as an "exit fee"). It should be fairly easy for you to find a lender that does not penalize you for prepayment.
Insufficient check fee
Most lenders will charge a returned check fee if you make a monthly payment and don't have enough in your bank account to cover the payment. The amount of the return check fee varies by lender but is typically between $25 and $50. The trouble is, an insufficient check fee is frequently deducted from your account before you even realize that your loan payment did not clear. If you tend to run your bank account low, the surprise deduction could lead to other payments being returned for insufficient funds. In addition, unless you carry overdraft protection, your bank could levy an overdraft fee.
One way to help avoid insufficient check fees is to sign up for autopay. Autopay allows the lender to deduct the loan amount from your bank account. Because it's deducted on the same day every month, it's easy to budget for, and you don't have to worry about forgetting to send a payment. In addition, you're likely to score a small discount on your interest rate when you sign up for automatic payment.
Late payment fee
If your payment is late, a lender may charge a late payment fee. Depending on the lender, the fee may be flat -- typically between $20 and $50, or based on a percentage of your loan amount. Percentage-based fees vary by lender but are usually 4% to 5% of the missed payment amount. Let's say your monthly loan payment is $400 and a lender charges a late fee of 4%. That means you'll own an extra $16.
Again, signing up for autopay and making sure there's enough in your account to cover the loan amount on the same day each month will ensure that you avoid late payments.
Once you've loan shopped and have loan offers to compare, sit down with your favorite beverage and use the loan calculator to help you figure out which loan is the best fit for you and your unique financial situation.
