While a few financial pundits and a lot more grandparents warn mightily against incurring debt, the changing shape of finance today makes the personal loan a safe and even smart option in many situations. Recently, we published an article on how a personal loan can even brighten your financial picture.
Five years ago and before, the fear surrounding personal loans was more understandable. Then, personal loan rates could be three to five times higher than a mortgage or car loan. Today, borrowers can get personal loans at rates just a point or two above a car loan rate and maybe 50% higher than a mortgage.
Quick Tip: Have you looked at your credit score lately? You can check your free credit score here at Credit Sesame.
Bottom line: it’s not unusual to see personal loan rates starting at 5.5% (for borrowers with the highest credit scores applying to online lenders, that is).
Personal loan myth #1: Bad credit borrowers don’t qualify
Just seeing a credit score below 600 can prompt consumers to put their heads in the sand for years. The good news is that bankruptcies and missed payments carry less and less weight the farther time marches on.
Some consumers who filed bankruptcy five years prior enjoy 700 credit scores now, given they’ve had good credit habits since that time. Checking your credit does not impact your credit score.
While you will have more limitations and higher rates than those with better credit scores, if the bad credit personal loan has a rate better than a 29% credit card, moving that money can be worth it.
Don’t be surprised, however, when asked to pay an origination fee or get a co-signer on the loan with you. Most likely, you’ll be limited to lower loan amounts than high-credit-score borrowers. Also, you may have better if you apply for a secured loan (read on).
Personal loan myth #2: You can only get one from your own bank
This incredibly widespread myth may have been accurate 20 years ago, but nothing could be further from the truth today!
As mentioned above, dozens of new alternative Internet and peer-to-peer (P2P) lenders have emerged in the past five years. You can query the rates of dozens of lenders and discover the rate and credit limit you qualify for without impacting your credit score.
Did you know: Only the lender you finally choose will make a “hard inquiry” into your credit score.
The key to finding the best personal loan for your situation is knowing your credit score.
Personal loan myth #3: Your bank is always the best source
The best source for you depends completely on your specific situation and credit rating. Banks and lenders do not all have the same personal loan requirements, not by a long shot.
Some banks are looking to fill their loan “portfolios” with high credit score borrowers who pay low interest rates. Others are looking to make more money by charging higher interest rates on lower amounts to low-score borrowers.
One lender may need more risk to diversify its range of investments. Another may go for only the most stable loans across the board. Banks and online lenders all have different “brands, ” servicing narrow niche markets with carefully tailored products they’ve made work for them.
Personal loan myth #4: You can only get one loan at a time
If you have the cash flow, the credit score and the right debt-to-income ratio, lenders will approve multiple loans. Keep in mind, however that the additional loan applications will ding your credit score, and the additional required payments will hurt your debt-to-income ratio, which is a factor for approval for some loans.
Therefore, if you know the total that you need, it’s best to push for one loan from one lender. You can ask for a loan officer with a higher “lending authority” than the one denying your loan amount. Loan officers have different authority levels.
Personal loan myth #5: No collateral is required
The two most common types of loans are “secured” which require collateral and “unsecured, ” which don’t. Home and car loans are secured loans because if you don’t pay, the bank has the ultimate right to sell the asset (collateral) to recoup the money it lent you.
An unsecured loan is basically a wager based on your income and credit score that you are a good risk to pay back the money. The lender of an unsecured loan cannot depend on an asset to recoup monies if you fail to pay or declare bankruptcy. The main purpose of bankruptcy is to wipe out unsecured loan debt and start anew.
It’s a common misconception that all personal loans are unsecured, and they need no collateral or assets to qualify. Some lenders are willing to lower interest rates or even qualify the borrower when an asset is put up for collateral.
While many personal loans don’t require collateral, borrowers sometimes choose to use a valuable asset like jewelry or a car to get a lower interest rate. If you go this route, however, understand that, if you default, you are at risk of losing family heirlooms or the vehicle that gets you to work.
Another type of secured loan is one made against cash that you have in the bank, usually in a Certificate of Deposit account that you won’t have access to while the loan is outstanding. If you deposit $1, 000 in the account, you can borrow $1, 000 from the lender. You still have to make regular payments, including interest, and if you default on the loan, the lender will take what it’s owed from your cash account. This type of secured loan is a great way to build credit.
Personal loan myth #6: It’s best to borrow more than you need
Just in case… right? Wrong. For two reasons.
While everyone should have an emergency fund amounting to six months of living expenses, creating that fund from a personal loan can get expensive and slow down the fund’s growth. Even if you get a low rate, it’s better to fill your emergency fund with earned money.
Every $1, 000 you transfer from your income to your emergency fund stays at $1, 000 (plus a little interest if you have it in savings or a money market). On the other hand, every $1, 000 you transfer from a personal loan to your emergency fund costs you. Given an 8% interest rate, you’ll pay $80 to put $1, 000 in the emergency fund. In the end, less goes in, and growth is stunted.
Just as the “little extra” can slow down your emergency fund’s growth, it also tends to push people out of their penny-pinching habits and into extravagance. It’s like that money is sitting in the bank account just waiting to be spent. Stick with the frugal mindset to succeed long-term.
Vozrozhdenie Bank (MICEX-RTS: VZRZ) is a Russian bank founded in 1991 and headquartered in Moscow. The bank provides personal banking and business services to clients in Russia through of a network that includes 161 bank branches and more than 780 ATM's.
The bank provides 1,600,000 clients with a range of services, from savings accounts...