Imagine you need funding to help pay for a large expense like buying a new car. There’s just one catch: You’re not sure how you should get started.
This post covers how to take out a loan and some key things to keep in mind throughout the process.
Step-by-step guide for getting a personal loan
1. Have a good reason for the loan
One of the first things you should do is determine whether you really need a loan or whether you want one. There’s a big difference.
Often, people rush into loans because it’s the easier and more convenient option to obtain quick money. Yet even if you can get the best rates possible, a loan isn’t always the best option.
That said, there are times when taking out a personal loan makes perfect sense. With that in mind, here are some loan options you might consider.
Home financing or home improvement
One of the most common types of loans is a mortgage loan, which most people take out when buying a home.
Once you secure a home, you may also want to explore a home equity loan for capital improvements and repairs if you don’t have enough cash in your savings account to cover them.
Putting money into a car isn’t the best investment decision, as a car depreciates in value as soon as you drive it off the lot.
Yet for many, a car is a basic need, especially if you have a family. What’s more, securing financing and buying a new car can potentially be less expensive in the long run than buying a used car and continuously paying for repairs.
Another reason you may consider taking out a personal loan is to pay off high-interest credit cards.
Suppose you have $10,000 of credit card debt with varying, fairly high interest rates. You could potentially take out a $10,000 personal loan with a lower interest rate and use the money to pay off your credit cards.
One of the best reasons to take out a loan is to further your education, assuming the class or degree you pursue lead to a higher income career. According to recent data, 15 percent of all student loans are private student loans rather than a federal student loan.
Funding a career change
Some also take a loan to fund a career change. You may take out a short-term loan while you learn a new skill and work as an apprentice or take on a mid-career internship.
You may need to take out a loan just to put food on the table, stay out of the bread line, or cover basic utilities. A personal loan should be a last resort. But it can work if you’re hurting for cash and need temporary relief. Just make sure you form a plan to get your feet back on the ground and out of debt.
Buying items you can’t afford
Sure, you may really want a bigger television or designer sofa. But chances are you don’t need to take out a loan to buy these large-ticket items—especially considering you’ll have to pay a loan origination fee.
Stick with the old-fashioned approach when it comes to buying expensive items and save until you can afford to buy it outright. Save a personal loan for necessities.
Taking an expensive vacation
We all get wanderlust from time to time. But taking out a personal loan for a vacation or even sabbatical is a risky play.
Again, save your money until you have enough to fund a nice vacation. And when you do, consider looking for ways to travel cost-effectively.
Investing in the stock market
Investing is very risky, and there’s no guarantee you’ll produce a return on your investment.
If you don’t have money to invest, don’t seek a loan, even if the company or fund you’re eyeing seems like a sure thing.
Paying for weddings
A typical wedding can cost anywhere from $20,000 to $30,000 or more on average when factoring in the cost of a venue, a band, food and drink, attire, and decorations, among other things.
Traditionally, both families cover some or all of the wedding. But this isn’t always the case.
If you can’t afford to pay for a fancy wedding out of pocket, consider scaling down or waiting until you’re in a position to fund it. There’s little point in going into debt for years to pay for a celebration—even one of that magnitude.
Another option is to put the money into a down payment on a house instead and have a backyard wedding. You’ll create the same great memories at a much better price.
2. Assess all your other options
Before you reach for a personal loan, consider any alternative options you may have.
Start a side hustle
If you don’t have an urgent need for a loan and can afford to go at a slower pace, consider starting a side gig to bring in more cash. You could drive for Uber or Lyft or use an app like TaskRabbit to find odd jobs.
If you allow yourself enough time and work as hard as possible, you could potentially generate the amount of money you’re looking for in a loan. Just remember to factor in taxes if you’re working as a 1099 contractor.
Sell unwanted belongings
In addition to working a side hustle, you could also sell unwanted items.
Look into a site like Decluttr to take your used electronics like televisions, media, or phones. You could also sell items on Craigslist or eBay or have a garage sale to get rid of larger items like bookshelves or furniture.
Another site you might check out is Nextdoor, which can connect you with neighbors in your area.
Look for alternative funding
If you really need to raise money quickly and you have a worthy cause, consider a crowdfunding site. These sites act like peer-to-peer lending, except you don’t have to pay the lender back. Instead, people make donations to your cause.
You may use it to pay for unexpected medical bills or to raise money when launching a business. Just think hard before going public with this type of initiative.
The rule of thumb is to avoid going to friends and family unless you really need money or have something that justifies asking. Putting an extension on your home or buying a new car probably doesn’t make this list.
3. Run a credit check
By now you should have a good reason for securing a loan and no other options for acquiring financing. The next step is to run a personal credit inquiry from one of the credit bureaus — Experian, Equifax, or TransUnion — to see what kind of loan term for which you’ll potentially qualify.
If you have a credit score of 670 or lower, consider trying to improve your credit before applying for a loan. If you don’t, you’re liable to receive an offer with a higher interest rate. If you have an average credit score, good credit, or excellent credit, you’ll be in a stronger position to move forward.
What’s more, you should look into the underlying reasons for your bad credit history. If you’re overspending or have other debt to pay off, you may want to reconsider taking out a loan unless it’s absolutely necessary.
4. Shop around
Once you’re ready to move forward with a loan application for a specific loan amount, shop around at various online lenders to compare rates.
You may even want to go to a local financial institution like a neighborhood bank or credit union if you have a relationship you could maybe use to secure a preferred rate.
At time of writing, some of the top lenders for personal loans include Lightstream, SoFi, Upstart and LendingClub. There are countless institutions offering personal loans. That being the case, it’s important to scour the market to find a loan that fits your needs.
Since applying for multiple loans at once can knock down your credit score due to the lender performing a hard inquiry on your credit, you should consider only applying to one or two loans to start.
When you find a loan you want to move forward with, go through the application process and wait for approval. Once approved, the funds should be directly deposited into your bank account for easy access.
5. Revisit your budget
Once you have a loan in place, you have to protect your money.
After all, you’re going to have a large sum of money at your disposal. How you spend it is most likely going to be up to you. Some loans may have restrictions, but the vast majority do not.
The first thing you should do is revisit your budget and put the money into what you intended.
For example, if you bought a loan to buy new windows for your house, don’t go out and use it to buy groceries. If you spend it freely, the money is going to disappear before you know it.
Tips for managing a loan
Avoid prepayment penalties
Some loans penalize you for paying down a loan too quickly. Always check the terms and conditions of a loan before you accept one and make sure you’re comfortable before getting started.
If your loan has a prepayment penalty, stick with a regular payment schedule so that you avoid paying the loan off too quickly and having a penalty assessed against you.
Always make your payments
Once you have a loan, it’s vital to make payments on time. If you start missing payments, a default notice goes on your credit report. This could negatively impact your score.
If you continue to miss payments, you’ll most likely face a collection agency. As such, it’s critical to be responsible about making payments when you take out a loan.
Simply put, a loan is not something to play around with.
Watch out for variable interest rates
You should also be leery of variable interest rates that can change throughout the course of a loan.
If an introductory offer seems too good to be true, it probably is. Consider sticking with a fixed rate for a personal loan so there are no surprises when your bill rolls around.
Frequently asked questions
Are personal loans harmful?
Personal loans aren’t always harmful. In fact, sometimes they can be very beneficial! Personal loans offer interest rates that tend to be much lower than credit cards, making them useful for funding large-scale projects or endeavors.
That said, loans can also be very harmful to consumers.
It largely depends on the type of loan, the interest rate, the term of the loan, and how you’re using it. Borrowers should be very careful and use good judgment when taking out a loan to avoid repayment trouble.
Should I take out a loan if I’m in debt?
Be very careful about taking out a loan if you’re already in debt. Make sure you’re doing it for the right reasons, like consolidating your current debt and reducing your monthly payments.
If you’re not careful, you could potentially double or even triple your debt with a personal loan, turning a bad situation much worse.
Is a loan better than a credit card?
A loan can be better than a credit card… assuming you can get one at a low fixed rate. It largely depends on your situation.
Another thing to consider is that loans don’t typically come with perks like credit cards do. If you’re seeking points or cash rewards and are good with making payments on time, look into a credit card.
What is a mortgage refinance?
Refinancing your mortgage entails swapping your existing mortgage for a new one. The bank pays off your existing mortgage and issues you a new one with a more favorable rate. This is a common move homeowners typically make after owning a mortgage for a stretch of time.
The Bottom Line
Taking out a loan is a major personal finance decision—and one that you should think about carefully before borrowing money.
If you borrow money, make sure it’s for something worthwhile like starting a small business, obtaining student loans, or making capital improvements on your home.
For the best results, you should also have stable income and be in a position to pay the loan back on time.
Above all else, scour the repayment terms before accepting any type of loan. Loans can have very high-interest rates and restrictive terms that can be easy to miss. Don’t get so caught up in eligibility that you forget to read the loan terms. That’s an easy way to bite off more than you can chew, leading to missed loan payments and problems with credit reporting agencies.
It’s also a good idea to use a loan calculator to determine the total amount you can expect to pay over the course of a loan after factoring in the annual percentage rate (APR).
At the end of the day, a loan can work wonders if it’s used for the right purpose. But if you get a loan and you don’t really need it, it can do more harm than good.
For the best results, consult with a trusted advisor to find out whether a loan makes sense for your unique circumstances.