What is a Personal Loan and How to Get One
You’ve considered debt avalanche and debt snowball and you’re a little freaked out about taking out a new credit card to pay off existing credit card debt with a balance transfer. Channel your best infomercial voice and say “there’s gotta be another way!” And there is. A personal loan is the fourth option for you to simplify your debt repayment process and pay it off ASAP.
What is a personal loan?
A personal loan (sometimes called a consumer loan) isn’t all that different from a student loan, an auto loan, or a mortgage. You borrow a lump sum of money from a bank, credit union, or online lender and then pay it back with monthly payments over the terms outlined in your agreement. The healthier your credit score, the better your chances for a low-interest rate. A personal loan is usually an unsecured loan and doesn’t require collateral. And while a personal loan doesn’t have to be used to consolidate debt, that’s what we’ll be discussing here.
Hold up, I take out more debt to pay off current debt?
Yes, that’s right. I know, it sounds trippy to take on more debt to pay off current debt, but in this case you’re going to basically consolidate and refinance your debt. You take the funds from the personal loan and use that to pay off all your credit card debt. Then, you focus on paying off the loan. It bundles all the credit card debts together into one, simple payment with a lower, fixed interest rate.
Why this can be a good strategy
A personal loan comes with a built-in plan. You know the interest rate, which can be fixed so there’s no hike in the interest during your repayment terms — unlike credit cards which have variable interest rates. You know the monthly payment amount and the loan term (aka how long until you have it paid off). This is a really effective way to pay off credit card debt, especially at a fixed-low interest rate with a single monthly payment instead of attacking multiple credit cards.
Plus, paying off your credit cards with your personal loan also means lowering your utilization ratio on those credit cards, which can help improve your credit score! As a reminder: utilization is the amount of available credit you use and accounts for 30% of your overall credit score. The rule of thumb is to spend no more 30% of your available limit (and the lower the better). For example, spending $300 of a $1,000 line of credit means you’re 30% utilized.
What is considered a low interest rate for a personal loan?
Single digit interest rates are the goal here. Competitive rates on debt consolidation personal loans usually start just under 6% APR but can go fairly high. Like credit card interest rate high. Not surprisingly, the higher your credit score and healthier your credit report, the lower your interest rate.
If you’re seeing offers for 16% up to 35% APR on a personal loan, then you’re heading into predatory lending territory. In the case that it’s at nearly the same rate as your credit card, so do the math to see if it’s worth taking on a personal loan. If it’s higher, then that’s a definite no-go!
You should shop around
You should absolutely be comparing offers from a variety of lenders. Check the offers from a credit union, a bank, and an online lender. You want to get the best possible deal. If you check your rates at multiple lenders within a 14 to 30-day window, then your credit score shouldn’t take a big hit as the algorithm can detect you were shopping around for a deal.
How do I know if this is a good deal?
Don’t worry, we’ve got your back! Click here and we’ll discuss what to look for (and look out for) when taking out a personal loan as well as what it can do to your credit score.