How to Qualify for a Personal Loan: Are You a Good Candidate?
Updated – January 16, 2019
When it comes to financial empowerment, more and more people are taking the reins by leveraging personal loans. This type of debt — which is considered “good debt“ if you use it to improve your financial health — has grown 11.4% over the last year, according to Experian. Numbers like these are firming up personal loans as a viable personal finance tool.
So how do they work? A personal loan is a lump-sum installment loan, typically ranging anywhere from $1,000 to $35,000, that you can use for a number of purposes, whether that’s to see you through a financial emergency or consolidate high-interest debt. The latter involves using a personal loan to pay off your outstanding balances. From there, you’ll have one new balance with a fixed monthly payment, repayment timeline, and an interest rate that’s ideally lower than what you were shelling out on your previous balances.
“I think that’s why a lot of people are turning to personal loans, because the interest rates on credit cards are getting so high,” said Laura Morganelli, a Philadelphia-based certified financial planner.
Common requirements for a personal loan
Interested in securing a personal loan? While every lender is different, most base eligibility on the following factors:
Your credit score
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. Translation: 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 interest rates as low as 3.34%, according to rates in MagnifyMoney’s personal loan marketplace (MagnifyMoney is a LendingTree company). Those who fall below a 640 credit score could end up paying anywhere from 5.99% to a whopping 35.99%.
If a low score prevents you from securing a personal loan that has a reasonable interest rate, Morganelli says that bringing on a cosigner, if you have one available, could be the thing that tips the scales. If that’s not an option, it’s time to revisit why you’re seeking a personal loan to begin with (more on this in a minute).
Your payment history
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% percent 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 seven years.
“Most lenders are going to be looking for a credit score that’s good or excellent, and they’re going to be looking at your repayment history,” said Morganelli.
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’ll 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. This little number 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 Morganelli.
2 questions to consider before applying for a personal loan
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 suggests 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.
“If it’s for a home renovation, for example, ask yourself if you really need to renovate the bathroom this year,” added Kelley. “Instead, is it possible to just be diligent and save for it over the next 12 months, then pay in cash?”
Of course, some expenses truly are unavoidable, especially if you’re face to face with 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 that 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, according to Kelley, paying off those credit card balances will reduce your credit utilization ratio.
If a less-than-perfect credit score is holding you back, Morganelli recommends 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 qualify for a personal loan on paper, it 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. For some, it may mean curbing your spending and making lifestyle tweaks until the loan is paid off. 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 0% 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 penalize you for doing so.
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 at earlier, 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.
3 steps to applying for a personal loan
- 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 loans, your credit score reigns supreme. You can check your information for free in a matter of minutes with this handy LendingTree tool, 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
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.
“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, be prepared to gather up the supporting documentation that your lender will need to process your application. This includes proof of employment, income and your residence, among other things.
Personal loans can be used to cover a variety of expenses, from unexpected bills to financial emergencies to high-interest debt. If you’ve decided this sounds like the right type of short-term financing for you, it’s time to take your financial temperature to see if you can expect to qualify.
Your credit score, credit history and income all come into play when it comes to locking down a personal loan with a competitive interest rate. From there, you can compare quotes online and shop around for the best deal.
For those stuck between a rock and a hard place, personal loans may be more cost-effective than other sources of financing, such as borrowing against your retirement fund or home.
“If you compare them to a Home Equity Line of Credit, most personal loans are going to have fixed interest rates and fixed monthly payments, which can be good in times that we’re in today with interest rates climbing all the time,” said Kelley