Are personal loans bad?

Personal loans are highly flexible loans that you can get from many different types of lenders. They’re popular for everything from funding home improvement projects to consolidating debt, but some people have negative perceptions about these loans.

You may be nervous about personal loans. Like any other loan, personal loans can be a useful financial tool when used properly. We’ll break down common personal loan myths and help you understand the essentials you need to know about them.

Common myths about personal loans

Personal loans are flexible loans that you can use for many purposes, such as consolidating credit card debt or funding home improvements. Interest rates on personal loans are usually higher than those of secured loans, like mortgages, but much lower than high-cost credit card debt.

Some people may have heard these myths about personal loans and why they’re bad. We’ll dispel these myths and cover when a personal loan may be a good fit for you.

Myth 1: Personal loans negatively impact credit scores

Any time you apply for a new loan, it will drop your credit score by a few points because the lender investigates your credit history and adds a hard pull to your report. That includes mortgages, auto loans, credit cards, and personal loans.

However, personal loans don’t uniquely have a negative impact on your credit. Like any other loan, it’s all about how you use the personal loan.

If you manage your loan well and make your monthly payments, a personal loan won’t usually hurt your credit score. It may even help you improve your credit by building your payment history or consolidating other debts.

Myth 2: Personal loans are hard to acquire

As with any other loan, lenders will go through an underwriting process when you apply for a personal loan, examining your finances and credit history. However, personal loans tend to be widely available from many lenders, including Rocket Loans, and underwriting is quick.

If you have good credit and a reasonable debt-to-income ratio, you can usually find a willing lender. Those with strong credit may be able to get a loan quite quickly, sometimes even the same day.

Myth 3: Personal loans are a financial burden

Debt is a tool, and it does not need to be a financial burden if used properly. This is also true for personal loans.

For example, if you have multiple expensive credit card payments, using a personal loan to consolidate those debts at a lower interest rate can actually ease your financial burdens rather than add to them. Using it for home improvement could add value to your home and improve your financial position.

It’s important to think carefully about your reasons for applying for the loan and whether you can afford the payments. Also, be sure to shop around with multiple lenders and get quotes so you can choose the best deal.

Myth 4: Only top-tier borrowers are approved for personal loans

Having great credit can certainly make it easier to get a loan, but you don’t need perfect credit to get a personal loan. Often, you can find a willing lender with a credit score as low as 610, which is considered fair rather than good or excellent. Rocket Loans typically requires a score of 640.

Advantages of personal loans

There are a number of benefits to using personal loans, so long as you apply for one in the right situation.

Debt consolidation advantages

A common reason to apply for a personal loan is to consolidate other debts. Personal loans are popular for debt consolidation because they typically have lower interest rates than credit cards, and you can often use one to borrow tens of thousands of dollars, which is enough to consolidate larger debts.

By consolidating your debts, you can replace multiple payments with a single, more affordable one. However, before you pursue debt consolidation, you need to think about your financial situation carefully, decide on how much debt to consolidate, and make sure that consolidation will really save you money in the long run.

Positive impact on credit score

In the long run, getting a personal loan can boost your credit score by improving a few of the factors that influence your credit.

• Adding to credit mix: A personal loan offers another loan product to the individual’s credit history, potentially improving the credit mix (a positive credit attribute).
• Payment-history impact: On-time personal-loan payments may be reported to credit bureaus; payment history has the largest impact on an individual’s credit score.
• Improving credit utilization ratio: Using a personal loan for debt consolidation could improve the individual’s credit utilization ratio. This ratio refers to the amount of credit used by the individual compared with the amount of credit extended to them.

Flexible spending options

One of the biggest advantages of personal loans is their flexibility. You can use the money from one for almost any purpose, which is different from loans with specific purposes, such as auto loans or mortgages.

How to maximize the benefits of a personal loan

You should view personal loans as a tool that you can use for better or worse. To get the most out of a personal loan, you need to make sure you use the loan carefully and for the right reasons.

Plan to use personal loans responsibly

Personal loans are flexible. That’s one of their greatest advantages, but also a danger. There’s nothing stopping you from getting a personal loan and using the money to take a vacation instead of doing something that will benefit your finances, like consolidating debt.

Your goal is to have your personal loan be “good” debt that improves your financial position long-term, rather than bad debt that hurts your finances.

Before you apply, come up with a plan for how you’ll use the money and how you’ll handle your monthly payments.

Leverage personal loans for financial growth

Used properly, a personal loan can improve your finances and put you in a better financial position.

For example, imagine you have three credit cards, all with an interest rate of 25% and a total balance of $12,000 across them. If your monthly payments totaled $370, you’d take more than 4 and a half years to pay off your debts and spend more than $8,200 in interest.

If you consolidate those debts into a personal loan with a 15% interest rate and a 4-year term, your payment would fall to $333.97, and you would only pay $4,030 in interest, saving more than $4,000.

When you get a personal loan, try to make sure it contributes to your financial position. Also, make sure you have a plan so you can always make your payments on time to avoid damaging your credit.

Considerations when applying for a personal loan

While personal loans are widely available and tend to be relatively easy to qualify for, it’s important to take some steps to make sure you’re ready to apply for one. Putting in the effort to do things like boost your credit and shop around with multiple lenders can help you get the best deal available.

Understand eligibility requirements

Every lender is different and will set its own requirements to qualify for a personal loan, but there are some general rules of thumb you can follow when getting ready to apply.

• Credit score: Personal loans typically require a minimum credit score of 610 – 640. To understand creditworthiness, individuals can request a free annual credit report from all three credit bureaus. Each bureau may also offer a free credit score.
• Debt-to-income ratio (DTI): DTI refers to the amount of monthly debt the individual carries in comparison to their gross monthly income. Many lenders prefer a DTI of less than 36%.
• Income: Lenders assess work history and income, and borrowers must understand that their income influences the potential loan amounts they are likely to be able to be approved for.

Compare lenders, rates, and terms

Whenever you’re making a major financial decision, such as applying for a loan, it’s imperative that you take the time to shop around and compare your options.

When it comes to personal loans, that means getting prequalified by multiple lenders. Each will give you a quote for how much you can borrow, the terms available, and the interest rate and fees charged. This lets you choose the best deal so you can get the cheapest loan possible.

Keep in mind that rates and fees are heavily influenced by your credit and financial situation, but shopping around is still important for getting the best deal.

Getting prequalified usually involves a soft pull on your credit, so it won’t affect your credit score.

The bottom line: Personal loans offer many financial benefits

Personal loans are like any other loan, they can be a valuable financial tool when used well. When you use a personal loan for something like consolidating debt or funding home improvement, you can actually improve your financial position despite the fact that you’re taking on debt.

If you think a personal loan may be right for you, you can reach out to Rocket Loans to see what you can qualify for.