You’ve probably heard financial experts recommend holding three- to six- months of living expenses in an emergency fund, and to use additional savings for discretionary spending. If you’re like most Americans, you don’t have either of these things. Close to 50% of Americans report having no savings, or only enough for one-to-three weeks of expenses. Among those with savings accounts, the average balance is just under $9,000. There’s a wide gap between common-sense financial advice spouted by talking heads and the day-to-day financial reality of the majority of Americans.
When tough times hit or jobs are lost or hours reduced, people often turn to personal loans to consolidate their debt or stay ahead of bills. Others need a personal loan for a wedding, home renovation, or an unexpected expense, like medical bills. The COVID-19 pandemic has increased applications for personal loans, but it has also led lenders to tighten restrictions on borrowing due to economic uncertainty and skyrocketing unemployment. Personal loan borrowers are twice as likely as mortgage and auto loan borrowers to be delinquent on payments. Also, over a third of personal loans in 2018 were taken by subprime borrowers, compared to less than 20% of credit cardholders, and just over 3% of mortgage borrowers.
If you’re considering a personal loan, here’s what you need to know.
Quick Facts on Personal Loans
- The national average interest rate for a personal loan is 9.41%, which is significantly higher than mortgage or auto interest rates, but lower than many credit cards.
- Interest rates range widely for personal loans, from 6% to 36%. Rates are impacted by your credit scores, free cash flow, and debt-to-income ratio (lenders look for less than 43%).
- Personal loans are usually unsecured, meaning there is no collateral (such as a home or car) to back it. Secured personal loans often provide better interest rates.
- Loan terms vary from a few months to many years.
- Over 38 million people have personal loans averaging $16,258, and higher balances have been growing in recent years.
Advantages of Personal Loans
- Debt consolidation. Paying off multiple lenders and having a single payment can save time and may help simplify or focus pay-back efforts and make on-time payments.
- Lowering cost of debt. Higher interest debt, such as credit card debt, can potentially be replaced by a lower interest personal loan.
- Relatively attractive interest rates. Personal loans can offer lower interest rates than other forms of debt, like credit cards.
- Quick turnaround. While some loans are processed in a week or two, others can take just days.
What to Watch Out For
- Interest rates and terms of personal loans vary widely, so it’s critical to compare offers.
- High fees. Personal loans may charge origination fees, processing fees and/or application fees. Assess the total cost of these fees before choosing a lender.
- Scams. Common warning signs include promises the loan will be approved, required upfront payment, and the lender reaching out first.
- Credit Impact. If you’re applying for more than one personal loan, do so within a 45-day window, that way credit agencies count all the credit checks as one, minimizing the impact on your credit score.
Alternatives to Personal Loans
While a personal loan may be the best, or only, financial option for some people, it’s important to consider alternatives that may be available.
- If you own a house, a secured home equity line of credit (HELOC) will likely have a lower interest rate.
- If you have a retirement plan, the Coronavirus Aid, Relief, And Economic Security waives the standard 10% penalty for non-qualifying withdrawals and allows distributions up to $100,000 (regular income tax is charged but can be spread over three years).
- If you are able to pay off your debt in a short time and qualify for a 0% or low introductory credit card balance transfer lasting a year or more, these terms may be preferable to a personal loan, even with the balance transfer fee.
Making The Right Decision
If you’re looking for a personal loan, it’s best to go into the transaction with as much information as possible about the marketplace for personal loans, and your alternative options.
Personal loans vary widely in term length and interest rate. U.S. News ranked the top lenders based on potential factors including offering small loans, lower fees, quickest available funds and customer service. At Experian, you can input your credit score and get matched to a loan that is right for you. If you are not the shopping type, you can reach out to a company that does the research for you. SuperMoney provides a list of loan offers from competing lenders based on your personal needs and the search does not impact your credit score.
We’re here to empower homeowners with personalized data and unbiased advice so they can make better financial decisions. If we can help answer any questions, or provide guidance on a refinance, personal loan, or other financial issue, email us at email@example.com.