Key takeaways
- A personal loan may be a less expensive option compared to other means of financing for big purchases or bills.
- Provided you use them responsibly, a personal loan can also help build your credit score.
- The personal loan space continues to grow rapidly, which means quick processing and funding timelines.
Personal loans often have more favorable interest rates than credit cards. They may also have better terms — although the way you spend money is less flexible.
Despite the benefits, personal loan myths may cause some borrowers to overlook them. But separating the myths from reality is essential to determine if personal loans are a good fit for you.
Personal loan myths
Learning the truth about how personal loans work and what the general requirements are can help you better assess if it makes sense for you to apply for one.
Myth: Personal loans require collateral
Fact: Most personal loans are unsecured, which means they don’t require collateral. Lenders typically charge more for unsecured loans, but there’s less risk involved for the borrower.
Personal loans do not always require that you provide an asset as collateral to get approved. In fact, many personal loans are unsecured. This means that lenders base approval on your credit score — not an asset.
Secured loans, such as car loans or mortgages, are backed by collateral. When you borrow a secured loan, the collateral can be repossessed if you fall behind on payments.
However, unsecured personal loans don’t require collateral. It may mean a slightly higher interest rate, but there is less risk than with a secured loan.
Myth: It is hard to get approved for a personal loan
Fact: How difficult it is to qualify for a personal loan depends on your unique financial situation. The better your credit and lower your DTI, the higher your chances of qualifying for a personal loan with a competitive rate.
Personal loan approval is generally based on just a few key criteria: your employment and income history, your credit score and your debt-to-income (DTI) ratio.
There is a widely held misconception that personal loans involve a daunting application process. In the past, a personal loan may have included completing a stack of paperwork and meeting a long list of requirements. While qualification requirements vary based on the lender, approval is far easier than applying for a mortgage and involves less documentation.
You can usually apply online in just a few minutes with most lenders. You’ll typically need to fill out a brief questionnaire. After, you may need to upload proof of income and employment as well as your address and documentation that confirms your identity.
Myth: Personal loans are not available for people with bad credit
Fact: Some lenders cater to borrowers with bad credit. The trade-off, though, is that lenders charge borrowers with bad credit higher rates and fees.
It’s easy to believe that personal loans are only available to those with the best credit, especially since marketing and advertisements often target these borrowers. While it is true that borrowers with solid credit scores are typically offered lower interest rates, it is still possible to get a personal loan with bad credit.
In some cases, these loans are secured to protect the lender from risk. There are also unsecured bad credit personal loans. Generally, they have higher interest rates and more fees.
Myth: Only banks offer personal loans
Fact: Personal loans are offered by various financial institutions. In addition to banks, some credit unions and online lenders provide personal loans.
The lending landscape has changed significantly in the last two decades. There are a variety of lenders that offer personal loans — not just banks.
Online lenders offer many benefits, including competitive interest rates and fast processing times. Some provide a lending decision in a matter of minutes and funding within two days of approval.
Credit unions may also offer personal loans. If you have an established relationship with the credit union, you may get a better rate than you would with a bank or online lender.
Myth: Personal loans always hurt your credit
Fact: If you make on-times payments on a personal loan, it could help build your credit.
When used responsibly, personal loans can help improve your credit score over the long term. As with any form of credit, the key is to repay the loan responsibly. Consistent on-time payments will help keep your score healthy.
Just like a car loan or credit card, applying for a personal loan results in a hard credit check. This credit check will have a temporary, negative impact on your credit score. By maintaining your loan in good standing and consistently making on-time payments, the impact of the credit inquiry will quickly be outweighed by the positive impact of the loan itself.
Myth: Personal loans are worse than credit cards
Fact: Average personal loan rates are often lower than credit card rates. That said, a credit card could be the better option if you can qualify for a 0 percent APR promo and pay off the balance in full before it expires.
For those with a good to excellent credit score and a stable income, the interest rate on personal loans is often lower than credit cards. You may even be able to find personal loan rates under 10 percent.
The national average rate for credit cards is over 20 percent. This means you may pay less interest overall by using a personal loan instead of a credit card.
Myth: Personal loans take a long time to process
Fact: Some lenders offer same- or next-day funding. As a result, personal loans can be an excellent choice for emergency situations.
Personal loans are one of the quickest ways to borrow money. Many lenders, particularly online lenders, are known for the speed of the entire process — from the application review to the deposit of funding in your account.
It is not unusual for some lenders to approve your application within one to three days and to provide funds as quickly as one to three days after approval. Some may even make funds available on the same day your application is approved.
Myth: You can only get a personal loan if you have a salaried job
Fact: Although it might be higher to qualify for a personal loan if you are self-employed, it’s possible to get one if you have at least two years of self-employment income.
Though lenders like to see a steady source of income, it is still possible to qualify for a personal loan if you’re self-employed or have other sources of income. You may be required to provide a few years of tax returns or recent 1099 forms instead of pay stubs from an employer.
Myth: You can’t get a personal loan if you have another loan
Fact: Whether you can qualify for a personal loan while you have other outstanding loans depends on how much debt you have compared to your income.
Every lender considers your DTI when applying for a loan. A previous loan can lead to a higher DTI — which may result in rejection. As long as you are able to handle the monthly payments, there are lenders that will allow you to have multiple personal loans
The same review criteria are applied to your application for a second loan as the first. Lenders will consider your income, current debts and credit score to determine whether you can successfully repay the loan.
Bottom line
Personal loans have many benefits when used responsibly. In addition to being available for nearly any type of expense, they typically don’t require collateral and have lower average rates than credit cards.
Before you take out a personal loan, weigh the pros and cons. If you decide they’re the right fit for you, compare multiple lenders to find an option that best matches your needs.
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