A personal loan can help you pay for virtually anything, from home repair to a medical emergency. You can even get one to fund your next vacation (though that is generally not recommended by financial experts). Of course, you need to qualify for one first before you can get access to that much-needed cash.
A personal loan is an unsecured loan. It doesn’t require you to pledge an asset in return for the loan. Generally, personal loans are installment loans with a fixed interest rate. The amount you borrow plus interest is divided into an agreed-upon number of months, the length of which is depended on the term of the loan. Unlike with credit cards, the interest rate does not fluctuate. Nor does the amount you need to pay each month. For these reasons, personal loans are a better option because you can easily plan your payments based on your monthly budget.
All lenders evaluate loan applications to determine a borrower’s eligibility. Because personal loans are unsecured loans (no collateral required), lenders tend to look at several factors to find out how much of a risk you are.
One of the factors that prove your ability to repay is how much money you make each month. In addition to that, lenders will also look at your expenses, specifically the amount of debt you have because this will also have an impact on your ability to pay off the loan. If you have a substantial monthly income but also a lot of debt, then you may not be able to make monthly payments on your loan. This is known as your debt-to-income ratio. Lenders calculate your DTI by dividing your monthly debt payments by your monthly income pretax. For example, if you pay $400 a month to your monthly debt payments and you earn $4,000 a month (gross), then your DTI is 10 percent. To be eligible for a personal loan, lenders prefer a DTI no higher than 43 percent.
Aside from your monthly earnings, lenders wish to see that you are steadily employed. This means that you will be more likely to have money to make on-time payments. Individuals who are self-employed like freelancers or those who frequently change jobs pose a higher risk because they may not have a stable income.
Take note that a good employment history does not mean you need to have stayed with the same company for years. What it means is that you have stayed in the same line of work and that you always have work or steady employment. For self-employed individuals, this means showing the lenders that your income is reliable with work history to prove it.
Lenders also check your credit history because it shows how you’ve paid off your debts and bills over the years. Any unpaid debts can remain in your credit history for seven years.
The most important factor that helps determine your eligibility is your credit score. Your credit score is a three-digit number (which ranges from 300 to 850) that tells a lender how trustworthy you are as a borrower. This is because it reflects your debts as well as your repayment history. Your credit score is calculated based on the information found in your credit report which is a detailed summary of your credit history – when and where you’ve borrowed money as well as how timely you were on paying your bills and debts.
Now, all that information is reported by lenders to one or more of the three credit bureaus – TransUnion, Experian, and Equifax. The information on your credit reports is then used by scoring models such as the Fair Isaac Corporation (FICO) to come up with a score that measures your creditworthiness. As we’ve already mentioned, the scores range from 300 to 850. Because there are more than just one scoring model and the fact that credit bureaus can also calculate your score for you using its own model, it’s possible for you to get multiple scores at the same time. Take note that If you have little to no credit history, then you might not have a credit score.
The credit score needed for a personal loan differs per lender. Typically, a high credit score for a personal loan will not only get you approval but higher loan amounts and a lower interest rate as well. For example, individuals with credit scores ranging from 720 to 800 can get an average rate of 10.3 percent to 12.5 percent.
Now, a credit score below 600 is considered poor credit. Many lenders would consider you a high risk and reject your application. This is because, according to MyFICO.com, more than 60 percent of people with poor credit scores default on their loans. For lenders, your credit score is a good indicator of whether or not you’ll repay your loan.
Does that mean that you need at least a 600 as your credit score to get a personal loan? Not really. The minimum credit score for personal loan approval varies by lender. Some lenders even specialize in offering personal loans to people with bad credit. Of course, there aren’t many of them. And you definitely won’t be getting any low-interest deals. But if you look hard enough, you may find something that would suit your financial situation.
Personal loans are available from a variety of financial institutions such as banks and credit unions. Banks, even your local ones, often have strict eligibility requirements. For example, Wells Fargo states that individuals with credit scores 620 and below may have difficulty getting approval for an unsecured personal loan with them.
Credit unions, on the other hand, are more lenient. They are more likely to lend you money despite your low credit score. In fact, there are even some that offer special programs for borrowers with poor credit history. However, you will have to be a member of the credit union in order to avail of these benefits.
Another good option for borrowers with poor credit history is online lenders. While some only offer loans to those with a credit score of 600 or higher, there are some online lenders who offer personal loans to those who scored 580 or below. However, you may be required to make some sort of trade-off such as paying high interest or putting up some collateral. Make sure that you understand the terms of the loan and that getting it will not put you in more financial trouble.
If you can’t find loan terms that are to your liking, there’s still one option for you – peer-to-peer lending. Instead of borrowing money from a financial institution, you can borrow from other individuals. With peer-to-peer lending, an individual lets you borrow from his or her own funds at an agreed-upon interest rate. This is somewhat similar to crowdfunding and another option for individuals who are unable to borrow money the traditional way.
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