There are all types of loans available to you, but one some don’t think about is a personal loan. There are a lot of advantages of how you can use that money. Keep reading below to see if it works for you.
If you are looking to borrow money for an “asset”, getting a secured loan isn’t all that difficult. As long as you can show a steady stream of income and a history of paying your bills, most banks will be willing to give you some money.
But what if you are looking for an unsecured loan? Unsecured means it is a loan with nothing as collateral. If you buy a house or a car and don’t make payments, the bank will just take the car or house back as collateral. An unsecured loan is far riskier for a bank but can be a necessary evil for some young folks.
An unsecured loan can also be known as a personal loan. These types of loans can be up to any amount, but you must be approved by a bank with a simple credit check before going too far.
As with anything, there are some advantages of a personal loan, but also a few red flags that you must consider before finalizing. A personal loan will have a set term and interest rate just like any other loan you have had in the past.
So, what is a personal loan for? That is where a personal loan can be very different from any other type of loan you may have had in the past. A personal loan can be used for just about anything. Maybe you have a home project you need funding for, a honeymoon you want to pay for, or maybe you are just trying to consolidate debt into one single payment.
Personal loans can be used on just about anything depending on the bank you use, although some lenders may have a few restrictions that they will cover with you. But just like a car loan or mortgage, once you are approved through the bank, the funds will be available to you, as well as the obligation to start paying back the debt.
Advantages of a Personal Loan
Flexibility: Perhaps the biggest advantage of a personal loan is the financial flexibility that it provides to you. As long as you qualify for the loan and agree to pay the money back, you are free to do what you want (as long as the activity is legal).
A prime example of how to properly utilize a personal loan is consolidating debt. My college roommate had no help paying for school and he worked his butt off all four years to make sure he was paying off as much as he could.
Then he broke his leg as a junior playing basketball at the rec, and he racked up an additional $10,000 worth of debt after surgery and therapy. This was a devastating blow to him, but one of those things he had to have done if he wanted to properly walk again.
Both college and the University allowed him to have payment plans, and after two years of starting his full-time job, he made sure both debts dwindled down to smaller amounts. Instead of paying two different payments (both with interest), he took out a personal loan and combined the amounts to have one monthly payment and a lower interest rate than both facilities were offering him.
After 24 months of payments, he saved more than $250 of interest and was finally debt free (from those two particular items).
Things to Remember: Even though a personal loan does come with flexibility, remember that you will likely be paying a higher interest rate because the loan is not secured. The better the credit you have, the better the interest rate. But if you are in a situation where you need money and don’t have the best credit, you could get a rate like a credit card.
Quick Turnaround: Another one of the advantages of a personal loan is the quick turnaround time. With just a simple credit application and approval from the bank, you can often have your money within 12 to 24 hours of applying for the loan. You’ll then have your lump sum of money, to do as you please.
I recently explored a personal loan for this exact reason. I was looking at getting into some real estate business on the side and needed some seed money to get me started. With real estate, you typically are forced to move quickly. I missed out on two deals right away because I wasn’t able to get my funding fast enough.
With a personal loan through my bank, I was able to get access to my funds within six hours of approval and I closed on my first real estate project. Without a personal loan, I don’t know if I would have been able to get my side business started.
For me, it was real estate, but for you, it could be many different things. Maybe you want to start a baking business but need an oven, or a mowing business but need commercial mowers. The point is, it doesn’t matter what the business is, a personal loan can help you get started.
Things to Remember: Having quick access to cash is a fantastic perk, but you better have your ducks in a row before considering a personal loan. If you can’t afford the monthly payments, you are at risk of getting sent to collections, who then could come after personal assets or garnish your wages.
There are zero loans out there that have zero risk involved, but taking a personal loan is really betting on yourself if you’re using the money to start a business. I would highly recommend making sure you have the funds to make at least six to twelve of the first payments giving your business a chance to be successful.
No Collateral: One of the advantages of a personal loan that I want to warn you about is the belief of having no collateral. First and foremost, a bank is not lying to you. If you qualify for a $10,000 personal loan, they will not ask for any collateral.
However, if you fail to make multiple payments, they can sell your debt to a debt collector who could attempt to collect payment through personal assets. A lot of this depends on how far behind you are in payments, how much you owe the bank, and many other factors. I just want to be clear, don’t think this is a free loan and if you don’t pay it back that nothing will happen to you.
Typically, what happens in the default of a loan is that the debt collector will garnish your wages and collect any upcoming payments like a tax refund. The good news is they won’t take all of your paychecks each week on a default, but most states allow them to take up to 20 percent, with some states being higher and lower.
Again, I don’t say this to scare anyone out of a personal loan, but if you do your standard good search on “pros of a personal loan”, a lot of literature will talk up no collateral as a huge benefit. If you pay your bills on time, that certainly is the case.
Low-Interest Rates (Considering the Alternatives): Another advantage of a personal loan with a bit of a sticking point is interest rates. When you consider them to your alternative which would be paying the minimum on a credit card and running up a balance, your interest rate should be fantastic.
Interest rates vary so much based on credit in a personal loan it’s hard to use an average, but even 10 percent interest is far better than up to 23 percent which would be charged by a credit card company.
For example, if you have a $100 balance that you let roll over each month, at 10 percent that balance becomes $285 (assuming no payments are made). That balance is $974 at 23 percent interest using the same assumption.
The big takeaway here is, yes, interest rates for a personal loan aren’t awful considering the length of term and the amount of money you are able to get. But it is worth noting that the rate isn’t going to be anywhere as low as a car or mortgage rate. Again, mostly because the debt you’re incurring is unsecured.
Things to Remember: Because of no collateral, on top of higher rates, there will also be more eligibility requirements. For example, you may need two years of consistent income when applying for a mortgage, but you may need four years or more to get a competitive rate with a personal loan.
The last item I want to point out is the increased fees and penalties that can come from a personal loan. The upfront fee for a shorter-term loan can be in the ballpark of five to seven percent, and the penalty for a missed payment can be big as well.
Obviously, the banks just want to keep everyone motivated to make payments, but the fees and penalties can add up quickly.
Please don’t take my “things to remember” section of the article as pessimism towards a personal loan. I have taken out a personal loan, and they are necessary in many different situations. My goal is only to inform and educate, so I did want to prepare you for a couple of items you may not think about before applying for a personal loan.
When to Avoid a Personal Loan
Above I discussed when the proper times to utilize a personal loan were. Many use this as a short-term loan to pay for a vacation, home improvement, consolidating debt, or even pay for a dream wedding. In a scenario where you have the cash flow to pay a monthly payment, but not a savings account big enough to bite off one big chunk, a personal loan is a perfect solution.
I would avoid a personal loan if you currently don’t have the cash flow to support an additional payment each month. What I mean by that is, if you currently bring in $4,000 a month, but are spending $4,100 a month, don’t take out a personal loan to go on vacation.
In the above situation, all you are doing is putting yourself upside down even more. To pay the loan, you will have to continue to dig into your savings each month or default on the loan. However, if you are bringing in $4,000 a month, spending $3,200 a month, and want to add a personal loan with a payment of $350 a month, that makes total sense. Your monthly spending will still be under your monthly income, which is always the most important thing when it comes to your finances.
I remember being 22 years old and just out of college with my first real job. I had two big car payments and a mortgage and really didn’t have my savings built up yet. I was making good money but couldn’t afford the exact engagement ring I wanted for my now wife.
I went to the local bank and applied for a personal loan. I was given the chunk of money that I needed to cover the ring, and even took out a little extra to go away for a nice weekend when I decided to finally pop the question. At the time, my interest rate was nine percent (which wasn’t too bad), and I had a term of 24 months.
When I was 16 months into the repayment, I received a nice end-of-year bonus from my job and was able to pay it off early. My bank didn’t charge me an early payoff fee and I saved myself a little bit of interest by paying it off early.
As you’ve read above, there are tons of advantages to a personal loan, you just have to be careful not to get sucked into a bad situation for yourself or your family. I would highly recommend a personal loan, but you do need to do your homework as with any financial decision you make.