You need to know your credit scores and research your options ahead of time to ensure you get the best rates and terms available. The place with the best rates for a good credit risk might not be the best for someone whose credit is only average.
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Your credit determines your options
The best credit risks (FICO scores 720 to 850) are almost always better off with a 0% introductory rate credit card than a personal loan. But any lender would be happy to have you as a customer, making large loans available at its lowest rates.
Good credit risks (690 to 719) who don’t qualify for a no-interest credit card typically find that a personal loan offers a lower interest rate than a standard credit card can offer. You may not get the lender’s very best rates and you may not qualify for the largest loans, but you should be able to find a loan easily.
Average credit risks (630 to 689) can be good candidates for personal loans at reasonable rates, especially if they have substantial income, positive cash flow or a lengthy credit history. You’ll pay higher rates, and you may face a higher loan-origination fee. But your credit score may exclude you under some lenders’ underwriting guidelines.
Bad credit risks (300 to 629) are unlikely to qualify for an unsecured personal loan at favorable rates on their own. Several online lenders consider additional factors — such as a co-signer or earnings potential — in making their underwriting decisions. Bad-credit borrowers, if they qualify, will find rates at the upper ends of lenders’ ranges, sometimes as high as 36% APR. Origination fees may be steep, and the size of the loan may be restricted. Some lenders may offer you the option of a secured personal loan instead, where you pledge your car or a financial account as collateral.
Unfortunately, the alternatives that don’t check your credit at all may be worse: High-interest installment loans, title loans and payday loans have effective interest rates of 300% or even higher. Almost any other choice — a loan from family, a part-time job — is preferable.
Some lenders have no minimum credit score to qualify for a personal loan, but that does not mean they do not look at your credit. The only difference is that a low credit score by itself is not a disqualifying event. Such lenders may look at your income, education level and college major in conjunction with your credit file.
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Where to look for a personal loan
Start with your local community bank or credit union. If you’ve been banking there for a while and the institution values you as a customer, you’ll get the best rate and loan amount. Credit unions typically offer lower rates because they are not-for-profit organizations. In either case, you probably will have to visit the bank or credit union in person to sign loan paperwork.
Compare their rates with those offered by online lenders, which conduct their business entirely online. Prime customers may see rates just as low or lower than those available from local banks or credit unions.
Online lending comes in a few different forms.
There are peer-to-peer lenders, such as Prosper and Lending Club, which offer both competitive rates and generous loan amounts for prime customers. Your loan is funded by investors — often by several — whose return is determined by how much risk they are willing to accept. The lender handles the paperwork and dispenses the payments.
Other online lenders draw their funds from more traditional sources but still offer unique twists. They may offer perks like flexible payments, no fees, a break on making payments if you lose your job, or advice from financial counselors.
Most online lenders will quote you an interest rate and terms during a preliminary application process that does not involve a “hard pull” of your credit reports, which can damage your scores. (A soft pull is just an inquiry and doesn’t hurt your credit; a hard pull is an actual application for credit and is noted on your credit report.)
Funds from approved loans are delivered electronically to your bank account, usually within a few days.
How to choose a lender
Shop for rates, but don’t shop only for rates.
The sheer competitiveness of the online personal loan market means lenders try harder to set themselves apart than traditional lenders do, either with lending guidelines that go beyond traditional credit-scoring models or with extras such as debt counseling and unemployment guarantees.
A half-point difference in interest rates on a five-year, $5,000 personal loan will cost an extra dollar or so a month. The flexibility to reschedule a payment, though, might keep you from missing a payment and incurring a late fee as well as a hit to your credit score.
Some lenders may make loans only for specific purposes. Payoff, for example, seeks only customers who want to consolidate their credit-card debt. And some credit unions will make large loans only if they’re for home improvements. But the vast majority of lenders don’t care what you do with the money.
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When to take out a personal loan
NerdWallet recommends personal loans only as part of a larger debt-management strategy — that is, if the loan changes your financial future in a positive way. Don’t borrow just because you can, and don’t borrow to delay the inevitable.
If you are borrowing money to spend it on a car, home renovations or a vacation, there are almost always cheaper options if you have excellent credit, such as a secured loan or a no-interest credit card. And if you have anything less than good credit, take a look at your existing debt and cash flow carefully before borrowing for such expenses.
Take out a personal loan to consolidate your debts for either of these reasons:
- The difference in payments will allow you to become debt-free more quickly.
- The difference in payments will help you avoid taking on more debt.
If you can’t meet either of those standards, consider delaying your loan if you can while you make an effort to improve your credit.
Lastly, if you cannot find a personal loan through a local bank or credit union, or at a competitive rate online, avoid the trap of payday loans and high-interest installment loans. You cannot afford 300% interest rates — no one can.
Instead, consider reaching out to debt counselors through the National Foundation for Credit Counseling and its member agencies. They can give you perspective and advice, and can even help you enroll in a debt-management plan that may reduce your finance charges.
Updated Oct. 18, 2016.