Established as an option for financing nearly any purchase, personal loans are a form of borrowing that provides a more favorable interest rate than a credit card. These loans have a relatively quick approval process and fixed monthly payments. Another benefit of this type of borrowing is that personal loans are unsecured, meaning there is no collateral required to obtain the loan.
Still, for all of the benefits associated with personal loans, there are many misconceptions about borrowing money this way. Here are some of the most persistent myths about personal loans.
Myth: Personal loans require collateral
Personal loans do not always require that you provide an asset as collateral to get approved.
There’s often confusion between secured loan requirements and unsecured loan requirements.
Secured loans, such as car loans or mortgages, are backed by collateral or assets. In the case of a car loan, the asset is the car itself, which can be repossessed if you fall behind on payments. The asset backing a mortgage is the house, which can be sold by a bank if you fail to remain current on your mortgage.
However, there’s no collateral requirement for unsecured personal loans. Be mindful that you will often get a higher interest rate than you would for a secured loan since there’s no asset for the lender to fall back on if you fall behind on the monthly payments.
Myth: It is hard to get approved for a personal loan
Personal loan approval is generally based on just a few key criteria such as employment and income history, credit score and debt-to-income ratio.
The widely held misconception is that personal loans involve a daunting application process that includes completing a stack of paperwork and meeting a long list of requirements to get approved for funding. While qualification requirements vary based on the lender, approval is far easier than applying for a mortgage and involves far less documentation.
In fact, you can usually apply online in just a few minutes with most lenders. You’ll typically need to fill out a brief questionnaire and upload proof of income and employment, address and documentation that confirms your identity.
Myth: Personal loans are not available for people with bad credit
Select lenders offer personal loans specifically for borrowers with bad or fair credit.
In some cases, these loans are secured to protect the lender should you default on payments. There are also unsecured loans for those with less than ideal credit. Generally, the interest rates on loans for those with bad credit will be higher, or the fees may be steeper than what borrowers with good to excellent credit would be required to pay.
It’s easy to believe that personal loans are only available to those with the best credit, as marketing and advertisements often target these types of borrowers. And while it’s true that borrowers who have solid credit scores are typically offered the most competitive interest rates on any type of lending, including personal loans, it is still possible to borrow money with a less-than-perfect credit score.
Myth: Only banks offer personal loans
The lending landscape has changed significantly due to financial technology, and it’s now possible to get a personal loan through an online bank.
Online banks offer many benefits including more competitive interest rates, as they do not have the expenses associated with running physical branch locations. Consequently,cost-savings are passed on to borrowers.
It’s also not unusual for online lenders to have faster processing times. Some provide a lending decision in a matter of minutes and funding the same day or in as little as 24 hours from the time of approval.
Myth: Personal loans always hurt your credit
When used responsibly, personal loans can actually help improve your credit score over the long term.
The key, however, is to repay the loan responsibly. Consistently making on-time payments and not missing any payments will help keep your score healthy.
It’s important to know that applying for a personal loan also prompts the lender to run a hard credit check to assess your overall financial health, which 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
For those who have a good to excellent credit score and a stable income, the interest rate on personal loans is often cheaper than that of credit cards.
Personal loan interest rates can currently be found for as little as 5.73 percent for those with the best credit scores. The national average rate for credit cards on the other hand is a steep 16.13 percent. So, despite their reputation of being one of the most expensive ways to borrow money, you’ll likely pay less interest overall by using a personal loan instead of a credit card.
There are many benefits associated with personal loans when they are used responsibly. In addition to being available for nearly any type of expense, personal loans typically do not require providing collateral and they come with an interest rate that is far more competitive than credit cards, especially for those who have excellent credit scores. Yet another benefit of personal loans is fixed monthly payments.
Though there continue to be many myths about this type of borrowing, personal loans can be a good choice for a variety of financial needs.