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Personal Loan Requirements — and How to Meet Them
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A personal loan is a lump-sum installment loan, typically ranging from $1,000 to $40,000 or more, that you can use to overcome a financial emergency or consolidate high-interest debt.
Snagging a lower interest rate is obviously ideal, but locking down inexpensive terms isn’t always easy. Personal loan requirements put your credit score, payment history and income under the microscope as lenders determine whether you qualify and which rates you could access.
Learning how to qualify for personal loan is an imperative first step if you hope to leverage this form of credit to improve your financial health. If personal loan eligibility seems too high of a threshold, we’ll review ways to improve your application for the future.
Personal loan requirements to prepare for
Interested in this form of debt? You’ll first need to familiarize yourself with how to qualify for a personal loan.
While every lender is different, most base personal loan eligibility on the following factors:
This is far and away the most important piece of the puzzle. Lenders view your credit score as an indication of how creditworthy you are.
A lower credit score suggests that you might be a risky borrower. Lenders protect themselves from this risk by tacking on higher interest rates, while reserving the most competitive rates and terms for those with excellent credit.
“If your score is less than 640, you’re probably not going to find a very reasonable personal loan,” said Michael Kelley, a Cleveland-based certified financial planner.
Borrowers with a credit score that’s 640 or higher may be eligible for APRs as low as 2.49%, according to rates in MagnifyMoney’s personal loan marketplace.
This goes hand in hand with your overall credit score. Your payment history carries the most weight when it comes to determining your score — it makes up 35% of your FICO Score. This is precisely why having a history of missed payments will come back to haunt you — a single late payment will stay on your credit report for up to seven years.
Again, what lenders are looking for is some degree of reassurance that you will in fact make good on your personal loan payments. A solid track record of making on-time payments will increase your odds of getting approved.
Before giving you the stamp of approval and writing out a check, lenders want to make sure you have steady money coming in to direct toward your payments.
“Outside of general credit score questions, they’re going to check into your income,” said Kelley. “They’re also going to want to know how much you want to borrow, and how long you want to borrow it for.”
Note that a shorter personal loan term translates to higher monthly payments: Let’s say you’re seeking a $15,000 loan with a repayment period of 10 years and an interest rate of 8%. Your monthly payment will work out to about $182, while a five-year term means a monthly payment of a little more than $300. While the shorter term means paying more from month to month, it’s actually cheaper in the long run because you would spend a staggering $3,590 less in overall interest.
Regardless of the repayment period, lenders really only care about one thing — after accounting for all your other existing debt payments, can your income cover this new monthly payment? This is where your debt-to-income (DTI) ratio comes into play.
Your DTI gives lenders an idea of how much of your current income is already going toward debt. To tally up yours, add up all your minimum monthly debt payments, then divide the total by your gross monthly income.
“If the average is 35% or lower, you’re considered a good candidate for a personal loan,” said Laura Morganelli, a Philadelphia-based certified financial planner.
2 questions to ask before worrying about your personal loan eligibility
Even if you meet personal loan eligibility requirements, you might not be suited to borrow. These are the most important factors to consider before pulling the trigger.
1. Do you actually need a personal loan?
This is perhaps the most obvious — but important — question. The idea of having a lump sum of cash delivered to your bank account almost instantly can be oh so tempting. Before making the leap, Morganelli suggested taking a good, hard look at why you’re seeking this type of financing in the first place.
“If you’re overspending and feel like you’re running a deficit on a month-to-month basis, applying for a personal loan to help cover that is never a good idea because you’re never going to have the means to keep up with what you’re spending,” she said.
In other words, turning to a personal loan to make up for ongoing shortcomes is a surefire way to dig an even deeper debt hole, which is why reckoning with your financial behavior is key. (We’ll dive deeper into this shortly.)
The same goes for financing some sort of big-ticket purchase you don’t really need, like a flat-screen TV or a last-minute European vacation.
Of course, some expenses truly are unavoidable, especially if you’re facing a stint of unemployment or some other large-scale financial emergency and don’t have a rainy day fund to fall back on.
Speaking of financial emergencies, if you’re currently tied to sky-high interest rates across multiple credit cards, that definitely deserves your immediate attention. Again, using a personal loan to consolidate debt and ultimately save money in the long run, is a no-brainer if you qualify for a reasonable interest rate and repayment term. What’s more, it’ll also pull up your credit score since paying off those credit card balances will reduce your credit utilization ratio.
If a less-than-perfect credit score is holding you back, Morganelli recommended paying down that debt and improving your score before trying again later down the road.
2. Can you afford a personal loan?
This is no small question. Just because you know how to qualify for a personal loan on paper doesn’t mean your budget can realistically absorb the new monthly payment, especially if you’re in the process of saving for other financial goals. LendingTree’s short-term loan calculator is an easy way to ballpark what your monthly payment will actually be, not counting any additional loan costs.
“Things to look for when considering a personal loan include prepayment penalties, application fees and origination fees,” said Kelley.
Every lender has its own set of criteria, but many personal loans do tack on an origination fee in the neighborhood of 1% to 6%. And if you’d eventually like to accelerate your payments and pay it off sooner rather than later, it would serve you well to go with a lender that won’t charge a prepayment penalty.
When all is said and done, personal loans are an excellent source of short-term financing if you can easily take on the monthly payment. But as Morganelli hinted above, this has everything to do with addressing your financial behavior so that the new loan doesn’t inadvertently end up strengthening the debt cycle.
“Is this something you’re doing to kind of slap on some tape and seal the leak, financially speaking?” she asked, warning that using a personal loan to cover overspending only delays the inevitable. At some point, the bill will come due.
How to qualify for a personal loan in 3 steps
Ready to jump-start the application process? Here’s what you can expect:
- Review your credit score and credit report
- Find lenders and get prequalified
- Shop around and get your paperwork in order
1. Review your credit score and credit report
In the land of personal loan requirements, your credit score reigns supreme. You can check your information for free in a matter of minutes if you open a free LendingTree account, which won’t affect your score. Reviewing your credit report once per year is another good habit. You’ll be able to see debts and accounts affecting your score.
Keep the following factors in mind as you review your credit report:
- payment history
- amounts owed
- length of credit history
- credit mix
- new credit
You can also pull your credit report for free every year at AnnualCreditReport.com. Through the coronavirus pandemic, consumers are able to access their report free of charge once per week.
If a lower-than-average score is standing between you and a personal loan, you can pay off your debt the old-fashioned way, using either the debt snowball or debt avalanche methods until your score improves enough to qualify.
2. Find lenders and get prequalified
Finding personal loan lenders these days is a relatively easy task, thanks to the internet. Using LendingTree’s personal loan tool, enter in some basic information about yourself and what you need out of a loan. You’ll receive loan offers which you can compare and apply for.
You can also apply directly with lenders on their website or in-person at a bank branch. Just ensure they’ll prequalify you without asking to perform a hard check on your credit report.
“That’s what’s nice about the flexibility of a personal loan,” said Kelley. “You have the ability to tell them exactly what you want and how long you want to borrow it for. In some cases, you can say how much you can afford each month, and the lender will work with you to find a loan that fits into your monthly budget.”
3. Shop around and get your paperwork in order
Once you’ve been prequalified, the next step is comparing quotes to find the best lender for you. Remember: Lenders don’t dole out money for free, so really read the fine print to make sure there aren’t any surprises.
“It’s not a one-size-fits-all situation, and each institution is going to have their own criteria, so really make sure you’re getting the best deals before getting into it,” said Morganelli.
When you feel good about your decision and you’ve landed on an interest rate, repayment term and monthly payment you’re comfortable with, prepare to gather up the supporting documentation to meet your lender’s personal loan requirements. This includes proof of employment, income and your residence, among other things.
Andrew Pentis contributed to this report.