How Do I Choose A Personal Loan?

Written by Publishing Team

A personal loan can help pay off debts, finance purchases or pay for vacation. Find out how to use a personal loan and the credit score required for a personal loan.


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Personal Loan Guide

A personal loan can be more cost-effective than a credit card for financing certain purchases. The more you understand about personal loans and how they work, the better prepared you should be to use the tool wisely.

What is a personal loan?

A personal loan is a form of unsecured debt — generally money from a lending institution such as a bank, credit union, or online lender — that is repaid in monthly installments over a specified period of time. A good way to understand personal loans is to think about where they fit with other borrowing options in terms of their limitations.

Credit Cards: Fewer Restrictions
A credit card gives you maximum freedom as a borrower. You can access credit whenever you want, for a variety of purposes — and as long as you make the minimum payment each month — you can change how long it takes to pay off debt. The problem is that credit card debt is, on average, more expensive than other forms of debt. So the best use of this type of borrowing is when you are able to repay it fairly quickly.

Personal Loans: Moderate Limitations
Personal loans fall somewhere between credit card debt and a mortgage or car loan. Can you use a personal loan for anything? Like credit card borrowing, personal loans usually don’t restrict how the money is used. In addition, they are usually not guaranteed, so guarantees are not required. Personal loans do have regulated repayment terms, but they are usually shorter than mortgages or auto loans (often three to five years for a personal loan, compared to four to eight years for auto loans and 15 to 30 years for mortgages).

Auto Loans and Mortgages: Most Restrictions
Mortgages and auto loans are much more regulated. They are used for a particular purchase, and the repayment term is specified. Repayment terms are usually designed to allow you to extend payments over several years – or even decades in the case of a mortgage. Because these types of loans are secured by collateral (i.e. home or car purchases), lenders can offer much lower interest rates than they would on credit cards.

What is a good reason to get a personal loan?

Personal loans can be used for many purposes, from paying for vacations to financing a large purchase. Some of these purposes are better than others, so how do you determine what is a good reason to get a personal loan?

Let the loan repayment term guide you. If you take out a loan that will take three to five years to repay, it must have an interest-bearing purpose that will last at least that period. Otherwise, you may find yourself in a cycle of constant borrowing where you don’t pay off your debts in full, let alone have a chance to start saving for the future.

In other words, it is better to use personal loans for unusual and long-term purposes, and only when you can fit loan payments into your budget.

Get a personal loan to pay off debts

Personal loans are often used to consolidate or pay off existing debts. Combining multiple debts into one monthly payment helps make debt management easier overall. Also, since personal loans generally have lower interest rates than credit cards, this tool can be used to reduce your interest expenses.

Are debt consolidation loans hurting your credit?
not in themselves. Personal loans with attractive interest rates may help you pay off credit card debt more quickly and thus help your credit rating in the long run. Unfortunately, if the debt load has already hurt your credit, it can be difficult to get a personal loan rate much lower than what you’re actually paying with your credit cards. Keep in mind that you should only use a debt consolidation loan as part of a budgeting system designed to reduce your total debt over time.

What is a good credit score for a personal loan?

Many factors go into getting a loan approved, such as the size and stability of the income. Many people ask, “How much should you earn for a personal loan?” There is no single income level that is used to qualify a personal loan.

Your credit score is pivotal not only in whether or not you get approved, but also in the suitability of the personal loan terms (such as the interest rate and loan term).

Each lender has its own criteria, but here are some general credit score thresholds that can affect your borrowing experience:

  • 740 and up (on a scale up to 850)
    This is considered very good to excellent credit. It should be easy for you to qualify for the most favorable loan terms.
  • 670 to 739
    In this range, your credit is half way through, so you should qualify for a loan with roughly average loan terms.
  • 580 to 669
    This is the territory of a major secondary borrower. If you qualify for a personal loan, it will likely come with a hefty interest rate.
  • 579 and below
    It may be possible to get personal loans for bad credit, but below this limit, you should think carefully before borrowing. This means that you may already have a debt problem, and any other borrowing that is likely to be at interest rates only exacerbates the problem.

There are many lenders out there, so be sure to shop around before choosing a personal loan. Compare rates for your credit score and situation, and review the repayment schedule carefully to make sure you can afford those payments.


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