The Skinny on Personal Loans
Let’s say you’re wanting to buy a home or upgrade your car but lack the funds to finance these purchases? It’s always nice to want to attain higher goals in life, but, what if your bank account just doesn’t support these ambitions? This is when credit expediently comes into play.
Credit is a convenient and practical way for you to make more manageable monthly payments for purchases that require a large sum of capital. There are many different types of credit, such as mortgages, auto loans, debt financing, personal loans, purchase financing, and credit cards. Each of them serves a specific purpose for the borrower to get financial backing without the burden of having to make bulk payments.
A personal loan runs around the same footing, however, the good thing about them is that they usually come with lower interest rates than credit cards and has a more flexible purpose. Because of this, a lot of people would rather get a personal loan for hefty buying decisions. Also, since personal loans typically have lower interest rates, a lot of people find them to be a more practical and feasible option for debt consolidation.
Credit can be a strong financial resource, but it also involves serious accountability. It is important that you carefully think through the advantages and disadvantages that can impact your unique credit picture before deciding to apply for a personal loan.
What is a Personal Loan?
A personal loan is money that you request to borrow from banks, credit unions, or lending agencies with which you promise to pay back within a set period. The good thing about personal loans is that they hold a more versatile purpose. While mortgage loans can only be used for home purchases, automobile loans can only be used for auto purchases, personal loans, on the other hand, is a loan that you can use for just about anything, such as medical expenses, home renovations, property acquisition, or even debt consolidation.
Like all other loans, lenders will peer into your credit ranking and review your application before approving your loan. A higher score will mainly make you eligible for a better loan term and a lower interest rate. Your debt-income ratio is also one other thing that they will take into consideration. Your debt-income ratio, or DTI, is a number that equates to the total amount that you owe each month versus the total amount that you earn. This is done by summing up your recurring monthly debt like student loans, credit card debts, mortgage, auto loan, etc., and dividing it by your total gross monthly income. The decimal result is converted to a percentage, lenders commonly look for a DTI that is less than 43%.
Lessen Inquiry Impacts
Lenders will always review your credit report when you apply for a loan. When this happens, a hard inquiry is noted on your credit report and stays there for approximately two years. However, the impact of hard inquiries typically phases out over time. But, having too many hard inquiries on your report within a short period can potentially damage your credit score.
With this in mind, it’s wise to have a shorter interval when applying for a loan with more than one lender to minimize the impact that hard inquiries contribute.
A credit scoring model usually tallies numerous hard inquiries for the same category of credit product as one single count if they occur within a short gap of a few weeks. The trick is not to spend too much time comparison shopping or applying for a loan for months on end, you can also ask your lender to do a preapproval or a prescreening of your loan offer. Preapprovals are considered as soft inquiries, so they don’t harm your credit score in any way as opposed to hard inquiries.
The Advantages and Disadvantages of Personal Loans
As with most types of credit, getting a personal loan can have its pros and cons, each one differing on your specific economic situation. In the end, the advantages and disadvantages of a loan are dependent on your financial management skills and your ability to pay.
The biggest advantage of getting a personal loan is that it helps you break down bigger payments into smaller segments, making it more manageable when you have a steady income.
Personal loans also have lower rates in interest as opposed to paying for something with a credit card and because they have lower interest rates, they’re a perfect option for consolidating multiple high-interest credit card debts into one single payment.
On the other hand, loans are also beneficial in establishing a positive credit history. Making on-time payments when you take out a personal loan results in positive credit scoring calculations and your responsible use of credit creates a positive influence on the other dynamics that are considered in scoring credit like payment history, credit history length, credit utilization, credit mix, and new credit.
On the downside, late or missed payments on your personal loan can cause a huge dent on your credit score and can hamper you from getting a good rate on your future loans.
If you are way behind your loan payments, your account could go into collections or could be charged off. Either way, they will both be reflected on your credit report and reduce your credit score. You might want to consider going into other debt-relief such as debt settlement or debt consolidation programs if you feel that it’s becoming a challenge for you to pay all of your bills on time.
Managing Your Personal Loan
Exercising proper financial management is the key to completing your personal loan’s term. When you execute the right amount of control and know how to pay your debts on time, then, personal loans can be a useful way for you to acquire things that you need now while paying for them in the future. Taking a careful look over your financial image is also crucial to make sure that doesn't get into something that might be too much for you to handle down the road.
One of the most recommended best practices before making a huge credit decision is to check on your credit report and understanding the credit standing that you are currently in. Reviewing your report gives you a birds’ eye view on how your credit decision now can affect your credit decisions in the future.