Personal loans 101: What to consider before borrowing

Personal loans can be used for almost anything, and they can be beneficial for various circumstances. Are you contemplating if a personal loan is right for you? There are dozens of factors to consider, like why you need one or the financial obligations. We’re breaking down the basics of a personal loan, its uses, and how to determine if you can assume the responsibility of taking on another loan.

What is a personal loan?

Personal loans are unsecured loans, meaning they don’t require collateral. They are borrowed in a fixed amount from a bank or credit union and are repaid in monthly installments. Unlike mortgages or car loans, they can be used for numerous reasons, like financing substantial expenses, debt consolidation, holiday shopping, and more. Lenders approve borrowers based on a few factors, like credit score and debt-to-income ratio.

How can I use a personal loan?

Personal loans can be used for countless purposes, but here are a few common uses:

Debt consolidation

Many people use personal loans to consolidate high-interest debt—debts with higher interest rates, like credit cards, are consolidated into one loan with a lower interest rate. This makes paying off debt easier because it’s one loan to keep track of on a set repayment timeline, rather than paying off multiple credit card balances. Using a personal loan to consolidate debt can also boost your credit score because it can lead to lower credit utilization and more on-time payments—two notable factors in determining your credit score.

Home improvements

Personal loans are also popular for completing home improvement projects. Because personal loans are unsecured, they require no collateral—unlike home equity loans, which use your home as collateral if you can’t pay back the loan. With a personal loan, you don’t risk losing your home, but that also means the interest rate is higher. Funding is also quicker—you can receive the funds in as little as one day after approval.

Holiday shopping

As previously mentioned, personal loans mean fast funding—which is why they’re frequently used for holiday shopping. Many people find that it’s easier to take out a personal loan to take care of holiday gift-giving for several reasons: interest rates are significantly lower than credit cards, and the loan repayment is easier because it’s one payment. It also helps you stick to a budget by only spending what you borrow. Personal loans for holiday shopping are recommended if you have good credit and are confident you can repay the loan.

Am I eligible for a personal loan?

Not everyone qualifies—if financial institutions lend to everyone, that’s a huge risk not only for them but for you as well. You should only take out a personal loan if you are positive you can pay it back. When applying, a few factors are considered: credit score, credit history, and debt-to-income ratio. But, your credit score is just the starting point—even though you might have a high credit score, that doesn’t guarantee you’ll qualify. Lenders also look at credit history—having an extensive credit history shows lenders how diligently you’ve made payments. Borrowers with multiple credit cards, a mortgage, or a car loan with regular, on-time payments may be more likely to qualify. Debt-to-income ratio, based on how much of your income is going towards paying off other debt, is also a significant factor. If your debt-to-income ratio is less than 35%, you may be a good candidate.

What should I avoid?

Taking out a personal loan does assume some risk, and there are a few things you should work to avoid—the most critical being defaulting. Defaulting on a loan means your payment is at least 30 days overdue, and it can severely damage your credit score. Defaulting can also stay on your credit report for several years and impact your borrowing power down the line. Another mistake people make is using a personal loan as a source of income—taking out loans to generate income and paying for daily expenses can quickly spiral out of control, and you’ll be drowning in debt before you know it. Lastly, borrowers often neglect not budgeting for a new loan. We know budgeting takes a lot of time, but it’s critical to know how much you can afford to pay per month and how much you can borrow.

While personal loans can be risky, the good outweighs the bad, and they can be a valuable tool when used properly—they can reduce your debt, raise your credit score, and even increase your equity if you use them for home improvements. If you need to consolidate your high-interest debt or simply need extra cash flow, a personal loan from Georgia’s Own may be for you. Click here to learn more about our Lifestyle Loans or apply today.