Disclaimer: Upstart is not a financial advisor, the following content is for informational purposes only.
Raise your hand if you’ve been affected by the cycle of high interest debt. If so, you’re not alone. Having high interest debt can be like running on a hamster wheel. Once you’re stuck on it, it’s hard to get off.
Taking out a low-interest personal loan, and using it wisely, can possibly alleviate some of your financial stress. You can use it as a debt do-over—only this time you can efficiently manage your finances.
Before you run out to a lender or apply online for a low rate loan, it’s important to do your homework and learn the basics. After all, taking out a personal loan, even one with a low interest rate, means taking on debt. You need to be prepared.
To help you get started, we’ve compiled everything you need to know about what a personal loan is, what you can use one for, and how you can use it to manage debt.
What is a personal loan?
A personal loan, also known as an installment loan, allows you to borrow a lump sum of money, typically anywhere from $1,000–$100,000. You can get this type of loan by applying at a financial institution like a bank, credit union, or online lender.
To qualify you and determine the terms and interest rate you’ll get, lenders look at factors including your credit score, credit history, credit report, and debt-to-income (DTI) ratio. Lenders look at these details to help them understand your creditworthiness, which is how likely you are to pay back your loan in full and on time. If the lender grants you the loan, you pay back the loan amount—plus interest—through monthly payments over an established repayment period.
Types of personal loans: secured vs. unsecured loan
Lenders offer two types of personal loans: unsecured loans and secured loans. The difference between these two types of personal loans is collateral. Unsecured loans, which are the more popular option, don’t require collateral, but secured loans do. Why?
Think of collateral as a safety net that lenders require to help them feel confident in your ability to pay them back. Collateral is a valuable asset, such as a car or home, that you own and you agree to use to back up the loan. If you default on your monthly loan payments, the lender will claim the collateral to make up for the loan total and payments you missed.
What can a personal loan be used for?
You can use the money you get from a personal loan on almost anything you want. Yes, even a vacation but we recommend that you opt for a reason that’s financially beneficial. Some of these include:
|Common Uses of Personal Loans|
|Credit card refinancing 💳||Moving expenses 📦|
|Medical bills 🏥||Home improvements 🛠️|
|Debt consolidation 💸||Special event expenses 💍|
|Funeral expenses 💙||Car repairs 🚗|
How your credit score can impact your personal loan interest rate
Lenders don’t automatically give qualified borrowers the lowest interest rate on a personal loan. The rate you get depends on several factors, but mostly on a very important number called your credit score. Let us explain.
When you fill out an application to take out a personal loan, the lender will learn everything they can about you. (No, we’re not talking about fun facts like your goldendoodle’s name). The lender will want to check your financial standing by evaluating your DTI ratio, credit report, and most critically, your credit score.
These details will help the lender understand how well you’ve paid off past debts. If you’ve paid past debts on time and in full, your credit score will be higher, which will improve your chances of getting a low interest loan.
On the “oh-no” side, a lower credit score shows lenders you’ve struggled to pay your past debts. If you have a low credit score, you could still qualify for a loan, but it will likely come with a higher interest rate. Or, depending on the score, a lender could also consider you too high a risk for a personal loan.
The lowest credit score that a lender will accept varies depending on the lender, but it can be anywhere from 620 to 680. Credit scores can range from:
- Excellent credit: 800 – 850
- Very good credit: 740 – 799
- Good credit: 670 – 739
- Fair credit: 580 – 669
- Bad credit: 300 – 579
If you’re worried about your credit score, there are ways you can improve it.
How to get the lowest personal loan rates
Believe it or not, it is possible to improve your chances of getting a low personal loan interest rate. All it takes is some extra time, a little patience, and some research.
- Check your credit report and your credit score. If your lender sees red flags like a low credit score, an outstanding balance or a ton of debt on your credit report, it’ll hurt your chances of getting a low rate loan. Get a free copy of your credit report from annualcreditreport.com and check it for any issues that need to be resolved and take the time to fix them. This will increase your credit score, help show progress on your report, and help increase the possibility of getting a good interest rate.
- Shop around and compare lenders. When you decide to get a personal loan, do not settle for the first option you come across. Why? It could mean the difference between a high or low interest rate. Different lenders offer different interest rates. So, do your research, compare what each lender offers, and base your decision on that.
- Ask about discounts. Some lenders offer discounts that can help lower your rate. For example, some online lenders offer interest rate discounts if you opt for autopay.
- Avoid fees. Lenders sometimes charge fees like an origination fee—a charge to take out a loan that can range from 1% to 8% of the loan amount. These fees are added to the Annual Percentage Rate (APR), a percentage that represents all of the fees and interest rate connected to the loan. If you get a lender that doesn’t charge an origination fee or other fees, it can help make up the difference in the interest rate.
- Get a co-signer. If you have a low credit score, it’ll possibly lower your chances of getting a lower interest rate. To help, you can have someone you trust who has good credit co-sign your loan, which could help you qualify for a lower interest rate.
- Opt for a secured loan. As we mentioned earlier, secured loans require collateral. While this loan option comes with the risk that you could lose your asset if you default, secured loans typically have lower interest rates compared to unsecured loans. Why? The collateral acts as an extra layer of security for the lender.
5 Ways a low-interest loan can help you financially
When you really think about it, taking out a low-interest personal loan, which is a debt, to pay for debt or to manage any other financial matter, can sound far-fetched. If handled responsibly, though, a personal loan can help you manage your finances better. Let’s look at some of the ways they can make a difference.
1. You can consolidate debt to pay bills
Even if you’re diligent about making your monthly payments, paying off high-interest debt, like credit card debt, can make it feel nearly impossible to achieve your financial goals. It may come as a surprise, but credit cards usually have a higher interest rate than personal loans.
Don’t believe us? As of October 2021, the average interest rate on all credit card accounts is 14.54% and the average APR on a 24-month personal loan is 9.39, a 5.15% difference. Because of the difference, many people use personal loans, also known as debt consolidation loans, to pay off credit card debt.
With this method, you can merge several debts into a single monthly loan payment from a lender that offers a lower interest rate. If you find a lender that offers a lower interest rate, you’ll save money and will be able to avoid missing a loan payment since they’ll all be combined into one.
2. You can improve your credit score
Yes, taking out a personal loan to replace your credit card debt can help increase your credit score. How? Credit cards are a form of revolving credit, which means they don’t have a fixed number of payments compared to installment loans. The lender will set a credit limit, which is the maximum amount you can spend using that card.
Each time you make a purchase with your card, you’ll have less credit available, but when you make a payment toward your balance, your available credit will increase. To understand how responsibly you’re using your credit card, lenders keep track of your credit utilization ratio, the amount of credit you have compared to the amount you’re using. If you have a high credit utilization ratio, lenders will view that as a risk, which can increase your credit score.
When you have a set repayment term (as with a personal loan), you have a set timeline to repay the loan, which will help you lower your credit utilization ratio and boost your credit score.
3. You can save money
Since personal loans require fixed monthly payments, they help create a clear path to paying off debt. This way, you’ll be able to determine exactly what you owe each month, and you can develop a plan to make progress towards short- and long-term savings goals.
4. You can make money in the future
While a home equity loan or a line of credit are common methods used to get money for a home repair or a home improvement project, personal loans can also be a solution. This option will make financial sense as long as the project will improve your home’s financial value and the cost to take out the loan is lower than the estimated appreciation of your home after the project is complete.
If you choose to sell your home in the future, the project you funded with the loan could help increase the asking price, which will be money in your pocket.
5. You won’t get duped into paying extra fees
Lenders often charge late payment fees, prepayment fees, returned check fees, and origination fees for personal loans. The good news is that you should never be surprised with extra charges.
Why? When it comes to personal loans, lenders are required by law to disclose any fees they’ll be charging you before you accept the loan. You can find all the details about fees, interest rates, and finance charges in the lender’s Truth-in-Lending Disclosure.
Personal loan: financial risk or financial boss move?
Even people who are financially healthy sometimes need a little extra help to reach their financial goals. If that sounds like you, you need to consider a few things first–like if taking out a personal loan will, in fact, benefit your financial situation.
To help you decide, do your research, think about what you’d like to achieve, and what the return on investment (ROI) will be. If you think the pros outweigh the cons, then get started today!