These 5 Myths About Personal Loans May Have Kept You Broke
When it comes to personal loans everyone and their mother have an opinion. Some say that getting a personal loan is a great idea, and some people feel that they are sent from the devil himself.
Today we are going to get down to the truth and expose 5 myths that are often said to be true about personal loans.
Let’s get right to it.
Myth #1: Excellent Credit Required
Personal loans are available for people with many credit degrees. Of course, if your credit is angelic, there will be more choices available and you will be able to pursue a loan more aggressively. Lenders offer their best rates to applicants with the best credit score.
Only a small part of the population has the “best credit”, yet most people are able to borrow in some way. Some personal loan lenders specialize in lending to those with lower credit scores or other difficulties. The main hurdle you will face with these companies is the payments. Your debt-to-income ratio will need to meet the guidelines (most likely 50% or less).
Interest rates vary widely, so it is very important to receive quotes from a number of competing lenders. Don’t be intimidated because your credit score is low and accept the first offer you receive. Shop and compare products from companies that work with consumers with credit ratings like yours. (This applies to all consumers, at every credit score level.)
Beware of “no credit score personal loans” advertised online and elsewhere. They are NOT personal loans. Many personal and payday loan lenders masquerade as personal loan sellers. You will know these fakes by their crazy claims and extremely short terms (two weeks to a month). And you will pay very high interest rates and fees. (An online search found loans with APR of up to 3600%!) Don’t go there unless you want to spend your life in a debt cycle, refinancing your loan over and over as your balance grows higher and higher.
Myth #2: Interest Rates Are Soaring
As of this writing, the average interest rate for personal loans is just under 11%. That’s more than most mortgages or auto loans, but they are completely different products. Mortgages and auto loans are secured loans. When you borrow to buy a house or car, you pledge that asset as collateral for the lender. This means the lender can repossess or foreclose if you don’t pay off the loan. And take your car or home.
This increased security means you pay a lower rate for guaranteed financing. The loan that most resembles a personal loan is the credit card. There are no collateral and the card issuer only has your promise to repay the loan. Hence, credit card issuers charge higher interest rates to offset the additional risk.
How much higher? The average rates of credit cards, at the time of writing, are about 7% higher than those of personal loans.
If your credit is excellent, some personal loan providers offer interest rates that are very close to those of home equity loans, without a home appraisal, title insurance, escrow services, and other costs. You don’t need home equity and your home isn’t in danger.
Finally, although most personal loans are unsecured, you may be able to obtain a reduced interest rate if you are willing to set up an asset (called collateral) to secure the loan.
Myth #3: You Can Cancel An Unsecured Loan
What happens if you don’t pay off your personal loan? The lender cannot take back your car. You won’t be coming home from work to find a foreclosure notice on your door. If you make your request in writing, the debt collectors can’t call you. Final warnings can be thrown into the trash and you can filter emails in seconds.
So it’s not that hard to borrow and default on an unsecured loan, right?
Mistaken.
Your lender’s safety is your promise to pay off, and there are ways to enforce that promise. Lenders can refer your account to a debt collection agency or their own collection departments. They can sue you and get a judgment — which, by the way, is a public record for all prospective lenders, employers, and owners to see.
Once the lender has a judgment, they may be able to garnish your salary, place a lien on your home, or empty your bank account. It depends on the laws of the state and the judge.
Myth #4: Personal Loans Are Hard To Get
In fact, applying for a personal loan is quick and easy. You can do it online, and you can get your money back in days and sometimes hours.
To put that into perspective, go spend a few hours at a car dealership with the finance desk and you’ll see how fun this process is. Or spend 30 to 45 days waiting for mortgage approval after providing a DNA sample and references from your last two exes and your babysitter (that’s over the top, but just a little).
In most cases, you fill out a short form, upload proof of income, your identity and address, and wait a few hours for a decision.
Myth #5: Applying for a Personal Loan Damages Your Credit Score
Some consumers find that adding debt automatically reduces their FICO score. This is likely because a new account lowers the average age of your accounts. Credit applications for personal loans temporarily reduce the score by about five points.
If you have a lot of credit cards running out and then apply for a personal loan, your FICO is likely heading south. Adding more debt when you already have a lot of open accounts with balances is a red flag and can hurt you.
However, if you use a personal loan to consolidate those depleted credit cards, you can raise your score and do it pretty quickly. This is because credit score models count installment debt like personal loans differently than revolving debt like credit cards. When your credit card balances are high above your credit limits, your FICO takes a hit. When your revolving balances exceed 30% of your credit limits, your score goes down.
When you use a personal loan to pay off your credit cards, that percentage, called the “usage ratio,” drops to zero. Stop carrying credit card balances once you’ve shifted that revolving debt into an installment loan and your finances and credit score will become healthier each month.
If you have very little information on your credit report, even a personal loan can boost your score. This is because you can be penalized for using too little or too much credit. Paying a personal loan on time can add good credit history and boost your FICO score.
Personal Loans: Sometimes They Really Are the Best
If you already have a home equity line of credit, it may be a cheaper source of funds than a personal loan. Low-interest loans or grants from the government or charitable organizations, when they qualify may be best for home repair or a down payment. People with severe debt problems may need more help than a personal debt consolidation loan, such as debt management or credit counseling, can offer.
However, many other consumers find personal loans to be the best way to finance many things. Personal loans usually have fixed rates substantially lower than credit card rates. So if you can get a lower interest rate and afford a debt-canceling payment with higher interest, a personal loan can help get your finances back on track.
Personal loans beat credit cards for large purchases when their interest rates are lower. Flat rates and payments make budgeting easier. You can use credit cards to get rewards or a low launch rate, then pay them back with a personal loan before the higher interest occurs.
If you don’t need a huge amount of money, personal loans can be cheaper than home equity loans, even if their interest rates are higher. It depends on the costs of setting up the home loan, which can be similar to those of a mortgage.
The reason why so many loan products are available is that there are many different needs. Just do your homework and adapt the financing to your situation. This way, you will pay less for everything you finance.
Compare interest rates on personal loans now.
