A personal loan is a line of credit that is taken out through a lender, which is paid back in pre-agreed upon monthly payments until the loan principal and loan’s interest is paid back in full. However, unlike a more traditional loan (such as a mortgage loan or an auto loan), a personal loan isn’t always backed by assets (such as the house or the vehicle, in the cases of mortgage loans and auto loans respectively), and so they can often be more a risky loan type for the lender. Because of this, it is usually easier to get a secured personal loan, by offering up collateral in the form of an asset that you own that is worth either a portion of or the entirety of the loan amount that is being sought out. Lenders of personal loans are usually banks, credit unions, or online lenders.
It was reported by TransUnion, which is one of the “Big Three” credit reporting agencies (CRAs) that unsecured personal loans reached $138 billion USD in 2018, which was an all-time high. Much of this growth came from loans that were given out by various FinTech companies. The average loan size, reported in the same findings, stated that in the fourth quarter (Q4) of 2018 were $8,402.00 USD. This average unsecured loan amount was across all risk tiers and lender types.
FinTech loans accounted for 38% of the overall loan activity that occurred throughout 2018, which is an increase of 33% when compared to the overall loan activity in 2013. Currently, FinTech companies are competitive with traditional banks, with average loan sizes being within the $10,000 USD range from companies representing both lender types. Credit Unions, on the other hand, only had an average loan size of $5,300 USD in 2018.
There are a number of things that we recommend you have a strong understanding of before you start applying for a personal loan. We recommend that you know what the Truth in Lending Act (TILA) is and how it protects you, and then we recommend that you know what the FICO score is and how to find out what your FICO score is. We will cover both of these topics below, and attempt to provide you with everything that you need to know about both of them.
After we cover the topics of TILA and FICO, we will then attempt to explain the various facets of personal loans (such as the types of personal loans and the actual steps of applying for a loan), in each of their own sections. Our goal in this article is to provide you with a strong foundation on which you can build your plan for obtaining a personal loan and repaying your personal loan, as this is something that can be incredibly important for your overall financial health and stability.
Understanding The Truth In Lending Act (TILA):
The Truth in Lending Act (which is also known simply as TILA) is a United States Federal law that was passed in 1968 and was designed to promote the informed use of consumer loans. This was done by requiring lenders to disclose the full terms and the total cost associated with a loan in order to standardize the manner in which the costs to consumers that are associated with borrowing are calculated and ultimately disclosed to the consumer. As the name makes clear, the entire goal of this Federal law was to increase the transparency and the truth regarding opening lines of credit with a lender.
Some of the most important aspects of TILA involve the requirement that information such as the annual percentage rate (APR), the terms of the loan, and the total costs to the borrower that will have to be paid in order to satisfy the conditions of the loan agreement must be conspicuous on all documents that are presented to the borrower before they sign them. In some cases, even after the terms have been accepted and the line of credit has been given, this information is even provided on the borrower’s periodic monthly billing statements.
The provisions of TILA apply to most types of consumer credit, including closed-end credit (such as both auto loans and home mortgages), and open-end credit (such as credit cards or home equity lines of credit). Understanding TILA is important for those seeking to take out a personal loan, because personal loans are protected under TILA, like most other loan types.
TILA has been amended and expanded numerous times in the decades since it was first brought into law, all in an effort to make it easier for consumers to compare different loan offers for all types of loans, regardless of whether or not the purchase is one that many people would deem to be “necessary”. TILA safeguards consumers from misleading and unfair lending practices that were gaining popularity in the 1950s in the United States.
In the late 1950s, the United States saw unprecedented growth in the amount of credit that was being issued. This growth in credit was being pushed forward by consumer credit, in particular the demand for housing, cars, and a variety of other products among the growing middle class. Unfortunately, this increased desire for costly goods caught the attention of money lenders that started to take advantage of these consumers, by misleading them about the terms and conditions of the loan, both with the language that they were using (such as advertising their loans as having “low monthly chargers” or that they only “take three years to pay” back the loan) and with the fee calculation formulas that they were using. After Congress investigated these many reports of shady tactics, TILA was created.
From TILA’s inception, the authority to implement the statute by issuing regulations was given to the United States Federal Reserve Board (known as the FRB). However, as of July 21, 2011, TILA’s general rulemaking authority was transferred from the FRB over to the Consumer Financial Protection Bureau (CFPB). Some states have—at the State law level—their own versions of TILA, but each of these variations all have the same core feature: the proper disclosure of important loan agreement information in order to properly protect both parties involved in the credit agreement transaction.
Finding Out and Understanding Your FICO / Credit Score:
FICO is a credit scoring system that was originally created by a financial company that was known as the Fair Isaac Corporation, but which is now known simply as FICO. The name of the scoring system that they developed comes from their original company name: Fair Isaac Corporation. The FICO credit scoring system is a way to assign consumers with a number that will give lenders, among others, an idea of an individual’s “creditworthiness” in order to easily be able to determine if that individual is likely to be a financial risk.
This number is extrapolated from five scoring sections that FICO thought to be the most important factors for determining someone’s creditworthiness, which are: your payment history (if you pay your debts back on time), your total debt across all loans and lines of credit, the age of your credit history (how long have you been paying back debts), the diversity of the credit types that are in your credit history, and if any “hard” credit inquiries or “hard credit pulls” have been made against your credit history recently. The FICO scoring system has a minimum score of 300 points, and a maximum possible score of 850 points.
Each of these five categories that FICO measures have a different importance placed on them:
- Your payment history: 35%;
- Your total doubt amount across all accounts: 30%;
- The age of your credit history: 15%;
- The diversity of the credit types in your history: 10%, and;
- Recently made “hard” credit checks: 10%.
The creditworthiness of a consumer is able to be determined from this FICO number, which is scored within a range. This range gives each of the credit scores a rating. For auto loans, unsecured loans, credit cards, and mortgage loans, there are five ratings (or tiers of risk): an “E” rating is assigned to credit scores that are 599 or below, a “D” rating is given to those that fall within the range of 600 to 639, a “C” rating is given to those that are between 640 and 679, next is a “B” rating for the range of 640 up to 679, and finally the best rating is the “A” rating which is given to credit scores that are 730 up to the FICO perfect score of 850.
However, there are only three tiers of risk for home equity loans, and loans for the following: RVs, motorcycles, and boats. These three tiers are: an “A” rating for scores that are 700 and above, a “B” rating for scores that are within the 630 to 699 range, and a rating of “C” for scores that are 629 down to the minimum of 300. Knowing what your credit score is, and what rating has been assigned to your credit score, is very important when it comes to applying for a personal loan, even if you’re applying for a secured personal loan.
Thankfully finding out what your credit score is has been made easy. Due to what’s known as the Fair and Accurate Credit Transactions Act of 2003 (also commonly known as FACTA), which is a Federal law, you can request a copy of your own credit report once per 12 months, at absolutely no cost. This free credit report is provided through joint cooperation between the three largest credit reporting agencies: Equifax, Experian, and TransUnion, which are known as the “Big Three” CRAs. If you prefer to request this free credit report via mail, you can print out and complete this form which can be mailed to:
Annual Credit Report Request Service
P.O. Box 105281
Atlanta, GA 30348-5281
Equifax, Experian, and TransUnion all also offer their own up-to-date information about your credit report, at varying costs. Or you can use a free credit report provider, such as Credit Karma, or similar. These free credit report providers might not report your actual FICO credit score, such as what you would see when using one of the “Big Three” credit reporting agencies, but these services can be used to supplement your annual free credit report by giving you a general idea of what your credit score is at any given time throughout the year.
Personal Loan Lenders:
You can get a personal loan from a variety of different places, depending on your specific financial situation and needs. Each of these lenders has their own pros and cons that are associated with them, and some lenders might not be willing to provide you with a loan depending on a variety of factors, such as the size of the loan being sought, the type of asset that is being attempted to be used as collateral, and/or if you are applying in person or online. The typical types of lenders are:
- Banks: these are the traditional loan providers that most people first think of. Typically when someone applies for a personal loan through a traditional bank, they will use the bank where they have their checking and/or savings accounts already, as this simplifies the process of proving assets and creditworthiness;
- Credit Unions: these lenders differ from traditional banks and most other financial institutions in one key way. The key difference is that those that have an account with the credit union are its (the credit union’s) members and owners, and they are the ones that elect the credit union’s board of directors in a one-person-one-vote system. This means that each voting member of the credit union has the same amount of voting power as every other member, regardless of the amount of money they have invested;
- Online Lenders: are a comparatively recently emerging and quickly growing entity in the world of finances. Mostly comprised of FinTech (Financial Tech) companies that only have an online presence, online lenders are one of the fastest ways to apply for, get approved for, and receive the funds of a personal loan, and;
- Non-Banking Financial Institutions (NBFIs): these are financial service providers that operate without a banking license. Sometimes also known as Non-Banking Financial Companies (NBFCs), the main difference between these lenders and the others is that they can not accept deposits from customers, due to the fact that they are not licensed to do so. NBFIs / NBFCs include both online and traditional brick-and-mortar financial companies, insurance companies, peer-to-peer (P2P) lenders and payday lenders. The main pros of applying for a personal loan through an NBFI is the fact that, despite usually having higher interest rates than typical, borrowers are more likely to be approved. P2P lenders can offer lower interest rates based on your credit score, but the interest rate will be considerably worse than more traditional lenders if you are viewed as a financial risk.
There are two types of personal loans that are typically lent out (unsecured personal loans and secured personal loans), and whether or not a lender offers both of these loan types—or if they just offer one or the other—depends on the lender in question. Not all lenders are going to offer both loan types, because how each loan works is very different for one key reason, which we will discuss in the following two sections.
Unsecured Personal Loans:
This type of personal loan is usually handled by a traditional bank, a credit union, online lenders, and some NBFIs / NBFCs. With an unsecured personal loan, there is no asset backing to guarantee that the lender will be able to recoup some of the costs associated with offering the line of credit in cases where the borrower has failed to repay the loan in full. This type of loan is based purely on the perceived credit-worthiness of the lender, and—as such—is often a more risky loan type for lenders.
The main determining factor for someone’s creditworthiness is what their FICO credit score is. We have detailed how FICO credit scores work, and how to find out what your FICO credit score is, near the top of this article.
By looking at what your credit score is, lenders are able to determine how likely you are to pay the loan back in full and on time. This is because FICO was created to reliably determine a consumer’s overall risk when it comes to financial debts and responsibilities.
FICO is not the only factor that most lenders will use when offering a line of credit, however. A lender can also attempt to determine your creditworthiness based on a few things such as your employment status, how long you have been employed by your current employer, how long you have lived at your current residence and your income. All of these, when used in conjunction with your FICO score, are able to paint a fairly strong picture of not only your financial stability but also your commitment to paying back your debts in a timely manner.
Secured Personal Loans:
As we stated earlier in this article, a secured personal loan is a loan where collateral has been offered as a financial guarantee that the lender will be able to recoup most of (if not all of) the amount that was loaned in case the terms of the loan has been defaulted on (such as failure to repay the loan). This type of personal loan is usually only handled by more traditional banks and credit unions, but are sometimes handled by certain NBFIs / NBFCs.
There are a number of things that can possibly be used as collateral for a secured personal loan, assuming that the lender in question agrees to accept it. Really anything that has actual market value that meets, or even exceeds, the loan amount can be an acceptable form of collateral. Some examples of assets that could potentially be accepted by a particular lender might include:
- Checking account and / or savings account balances;
- Future employer paychecks / future income;
- Investments / Stocks;
- Professionally appraised art;
- Real estate, and;
- Recreational Vehicles (RVs), among similar assets.
It is important to note, however, that very few major lenders will accept car titles, real estate, or collectibles as collateral for a secured personal loan. Many of these major traditional lenders will only accept money that is in your banking account or savings account or money that is in an investment account. This ultimately means secured loans using a less commonly accepted form of collateral is usually not a good option for people that are trying to prove their creditworthiness but are instead more suited for people that are looking to obtain a lower interest rate on a personal loan that they are already more than qualified for purely based on their creditworthiness or the monetary value of their more traditional assets. In the end, what forms of collateral will be accepted for a secured personal loan can vary greatly from lender to lender.
It is also important to know that not every lender will offer both personal loan types, and so it can really benefit you to do proper research, such as the differences between both of these personal loan types, what your options are for collateral based on what a lender will accept, and even doing research on specific lenders as a whole. Reading online reviews of others that have previously used a specific lender is a great way to get some insight into how that lender handles business and treats their borrowers.
How To Know If Applying For A Personal Loan Is Right For You:
Deciding to apply for a personal loan can be a big decision for many people, but personal loans are incredibly flexible in a variety of different situations. There are many reasons that someone might want to take out a personal loan, such as:
- Debt consolidation: with a personal loan, you can pay off all of your existing debts, so the only debt that you will have is the personal loan itself. This can be incredibly beneficial for a number of reasons, with the chief reason among them being the fact that you can probably get your personal loan’s interest rate lower than the interest rate(s) that you are currently paying for your other debts, decreasing your monthly repayment costs and the total cost of the amount of money that you owe as a whole;
- Emergency expenses: planning for an emergency can be difficult for most Americans, and sometimes people just need a personal loan in order to cover an emergency expense that they were not able to account for, such as expenses related to an emergency hospitalization or sickness (such as missing work, the cost of the hospital/doctor visit itself, the cost of medications) or expenses related to something like emergency car work;
- Home remodeling/repair : taking out a personal loan can get you a large lump sum which can be used to pay for the costs associated with remodeling your home or with repairing something that has gone wrong with the home, such as replacing drywall or repairing leaky plumbing;
- Wedding / honeymoon expenses: weddings can (and often are) expensive affairs that many hope to be once-in-a-lifetime occurrences. If you are financially stable enough that taking out a personal loan will not become a financial burden for you, then it might not be a terrible idea to think about taking out a personal loan to help with any wedding and/or honeymoon expenses;
- Vacation costs: the same logic applies to taking out a personal loan to cover the costs of a vacation as does taking out a personal loan for wedding/honeymoon expenses. If your finances will allow for you to comfortably make the loan payments each month, then taking out a personal loan to fund a vacation could be a viable option for you to consider, and;
- Other large purchases: because personal loans don’t have to be really large sums, you can use a personal loan in order to get a smaller lump sum in order to make a purchase that is typically larger than normal, but not as large as the previously listed examples. For example, you could use a personal loan to buy new kitchen appliances or a new furniture suite.
There can be many reasons that you might want to take out a personal loan, however, there are two situations where taking out a personal loan might not be the best financial decision, if possible:
- College tuition costs: because student loans are generally better suited to paying for college tuition costs, taking out a personal loan to cover these costs instead is unlikely to be the best decision. Student loans usually have better interest rates and longer terms, allowing for smaller monthly payments and a longer amount of time to repay the loan back, and/or;
- Auto financing: auto loan interest rates are typically lower than personal loan rates and are generally easier to obtain than a personal loan because there is already an asset that is associated with the loan that can be repossessed by the lender in the event that the terms of the loan agreement are broken.
There is nothing to say that you can not take out a personal loan for these two reasons (or for any reason that you want to), assuming you are able to find a lender that is willing to offer you a loan agreement, but it would probably make more sense to apply for the appropriate loan types instead. If you want or need to take out a personal loan in order to supplement these loan types, then that might be something that is worth looking into, however.
The Steps of Applying for Either an Unsecured or Secured Personal Loan:
When taking out a personal loan, you will need to find a lender that is right for you. Once you have picked a lender, you will need to fill out a loan application. Depending on the lender that you have chosen, you may be able to complete the application process entirely online, or you may need to do a part of (or all of) the application process in person at the nearest local bank branch or credit union branch.
When filling out the application, you will need to provide the lender with some specific information, which can vary from lender to lender. Typically, however, you will need to provide your legal name, your home address, contact information (such as your home phone number and/or your cell phone number), your monthly or annual gross income, your employment information (if you’re classified as an employee, a worker, or if you are self-employed), contact information for your employer (if applicable), the reason for seeking a loan, and how much you are seeking to borrow. Depending on the loan provider, you may also need to provide them with further information or documentation, with some frequently requested items being: a copy of your latest pay stub, a copy of a state-issued picture ID (such as your state driver’s license, a DMV-issued photo ID for non-drivers, a passport, some company-issued employee ID cards, or a Native Tribal Card), proof of residence, and/or your latest tax return information. Any and all requested information and documentation will be used by the lender to ensure that they can extend a loan offer to you, so the faster that you are able to provide them everything that they request, then the sooner you can possibly have the personal loan funds accessible to you.
The preceding steps are the same for both personal loan types, however, for secured personal loans, there is additional information that you will be required to provide, regardless of the lender. This information is what your collateral or assets are that you are offering as a backing for the loan amount. You will have to offer an asset that the lender will accept (usually an owned automobile or house) and then provide proof of ownership (such as the title to the vehicle or the deed to the house) and further provide any necessary information that they might need in order to determine the market value of your collateral. After this has been completed, the process of applying for both types of personal loans are generally the same again, as this is the key divergence between the two processes.
So, after providing the lender with the necessary information for the type of loan that you are applying for, they will typically need to perform a soft credit check of your credit score. Depending on your credit score, you will likely be given a few different options to choose from regarding the loan type and the loan agreement. Once you have settled on the loan amount, the loan type, and the conditions of the loan, you will be able to proceed to the steps of finalization for the loan.
The final steps that you will need to complete before being granted the loan are to review the terms and conditions of the loan (including any associated fees, the length of the repayment period, and when your first payment towards the loan is due), read the fine print of the loan agreement (to ensure that you are fully aware of exactly what the loan agreement requires of you), and then sign the loan agreement that you and the lender have agreed upon, assuming that you have decided to commit to the loan.
Once the loan agreement has been reviewed and signed, the lender will notify you of your loan’s approval status, usually in-person immediately after you have signed the loan agreement. Typically the loan funds will be accessible to you within a period of time that depends on the lender in question. With many traditional banks and credit unions, you can have the loan funds deposited into your banking account within a week, but some FinTech lenders are able to have the loan funds deposited in your banking account within just one or two business days for most loan agreements.
Once you have received your funds, it is recommended that you make a note of when your first payment is due, and to have a plan for your repayment of the loan. This can involve something as simple as making personal notes on a calendar, or even setting up an automatic payment process through your personal bank with funds being withdrawn directly from your checking account. Some lenders will even offer borrowers a discount on the personal loan’s interest rate if you set your account up to make automatic monthly payments towards the loan’s repayment.
Increasing Your Chances of Being Approved For A Personal Loan:
There are a number of steps that you can take to help increase your chances of being approved for the personal loan amount that you are seeking. In this closing section, we will provide some general tips that should be helpful in most situations:
- Increase your credit score: by increasing your credit score, you will be perceived as a less risky borrower to lenders, which not only increases your chances of being approved for a personal loan but will also play a role in helping you to get a better interest rate on your loan;
- Rebalance your debt-to-income ratio: personal loan lenders ask potential borrowers to provide proof of annual income and your monthly debts. By lowering your debt-to-income ratio, you will be able to show to the lender that you are not only financially stable enough to take on any new debt, but that you are also increasing your chances of entering into a personal loan agreement for higher amounts than what would otherwise be possible;
- Consider asking someone to cosign: having someone with a strong credit score—particularly if yours isn’t that great—can help to increase your chances of being approved for a personal loan. A cosigner just gives the lender a better chance that they will actually see the loan being paid off in full;
- Be reasonable with the amount you seek to borrow: asking a lender for a very large sum of money, particularly if you do not have the credit score and debt-to-income ratio that would make getting a very large loan more feasible, is a surefire way to get your personal loan request swiftly denied;
- Know your assets: by knowing the worth of any and all assets that you are willing to use as collateral for a secured personal loan, and which of your assets a specific lender will even accept as collateral for a secured personal loan, then you won’t end up wasting your time trying to get a personal loan that is more than the market value of your asset(s), or end up wasting your time by trying to get a loan from a lender using an asset that they are unwilling to accept as collateral;
- Shop around for the right lender: finding a lender that is willing to work with you, or that is able to offer you loan terms that are right for your specific financial situation and needs is an incredibly important part of being able to get approval for a personal loan. Some people apply to one place for a personal loan, and if they get turned down, just assume that all lenders will turn them down, which isn’t always the case, and;
- Pre-qualify with multiple lenders: Pre-qualifying with multiple lenders will not only let you easily compare the terms and conditions of each lender’s loan offerings, but will also greatly increase your chances of actually being able to secure a personal loan from of the lenders that you have pre-qualified with.