At present, the interest on an unsecured personal loan is currently over 15% per year, says BankRate.com, assuming you can get this type of loan at all in today's credit-starved environment. And that's about your best such rate. Attempt to borrow against a credit card, for example, and it could have a good deal more. It's obvious that personal loans can get very expensive nowdays.
In many situations, though, a personal loan can be just about unavoidable for many of us. What if the car will not start and you need an expensive engine repair to get it up and running again? Or your daughter needs braces? Or the washing machine breaks down?
Situations like these force many Americans to resort to personal loans, including high-cost payday loans. These loans now make up over 22% of the total non-mortgage install loans at US banks, up from only 11% in 1998.
However before you sign up for your next personal loan, consider the following alternative possibilities –
– Consider a home equity loan. If you own a house with equity in it, you can probably borrow against the equity at a fairly low interest rate and at the same time get a tax deduction. Check out LendingTree.com for a list of lenders.
– Selling stocks, Treasury bonds, etc., can be a fast way to drum up some hard cash – just be sure you understand you'll have to pay taxes on any gains or interest.
– What about borrowing against your cash value life insurance policy.? This is a low-interest alternative if you have this type of policy, and it's the most common type.
– Try borrowing against your retirement account. Ask your employer's benefits department if this option is available. If so, it's another low-interest alternative.
– Family or friends. Maybe your dad can fork over some cash. Just make sure you pay him back.
– Ask your creditors – particularly local merchants who may be more flexible – if they might be willing to extend your payments a month. If they are, make sure you're not getting charged extra for the privilege of paying your bill late – or if you do get charged, find out how much.
– How about asking your employer for a pay advance – assuming of course you have an understanding employer.
Good vs Bad Debt
You need to recognize a simple fact of personal finance: Never borrow money for consumption. That's bad debt. Only borrow for investments that will increase in value (and increase by more than the cost of the loan). Borrowing money just in order to spend it is a terrible idea, a royal road to bankruptcy or other financial land mines. As Eric Tyson says in his book, PERSONAL FINANCE:
If you spend, say $ 2,500 [which you've borrowed] on a European vacation, the money is gone. Poof! You may have good memories and even some Kodak moments, but you'll have no financial value to show for it … I'm not saying that you can not take a vacation. Definitely, take one, two, three, or as many as you can afford annually. But that's the point – what you can afford. If you need to borrow money … [then you can not afford the vacation] …
And strictly the same advice applies to almost any consumer purchase: home computers, expensive meals, clothes ,, yes, even a new car – anything that decreases in value and eventually becomes financially worthless. If you have to borrow to buy it, you probably can not afford it. According to Tyson "The finitely correct amount of bad debt [you should have] is zero."
But this does not apply to things that "retain and hopefully increase in value over the long term, such as an real estate, education or your own business." For these uses, debt is acceptable, up to a limit – the limit being the point at which making payments causes you to be no longer able to save adequately to accomplish your financial goals.
All that is excellent advice, but the fact is that, at times, you simply may not be able to avoid adding to your debt load – an emergency or other urgent situation forces you to seek a personal loan. In those kinds of situations, what are your best options?
Personal Loan Essentials
Here are a few basics to keep in mind whenever shopping for an unsecured personal loan:
First, never borrow more than you need. Given the high interest rates in today's credit environment, you'll want to keep the amount to an absolute minimum.
Second, compare terms from several lenders. Never look at just the monthly payments – consider the total cost of the loan, including any hidden charges like credit insurance or other fees. Do not skip the small print on the loan agreement. Do not assume what you're being told by a loan officer is binding. It's what's in writing in the contract that counts.
Third, begin by trying your credit union before a bank. Credit unions usually have more favorable terms than banks and are often willing to make small unsecured personal loans to their members.
Fourth, do not pledge valuable personal assets when you take out a small loan – it's almost never worth the risk. And avoid using credit cards or payday loans if at all possible – the interest rates, especially on the latter, can be prohibitive.
Fifth, be aware that the interest you pay on unsecured personal loans is not tax deductible.
Understanding Subprime Loans
If you find yourself in the subprime lending category, things get even more complicated. As you know, subprime lending has tightened up greatly over the past months (and is now almost nonexistent in the mortgage market). However, if you are employed, you can still find cash in an emergency – you just have to be prepared to pay a steep interest rate for it.
But what exactly does the term "subprime" mean? The definition varies by lender, but in general subprime means a FICO score of 650 or below. Among the other criteria commonly used are: a bankruptcy within the past five years, a foreclosure within the past 24 months, or a debt-to-income ratio of 50% or higher. Some ultra-conservative lenders will even brand you as subprime if you've been late on one or one or two credit card payments over the past 12 months.
There are some important factors to bear in mind if you're considered subprime and yet need to take out an emergency personal loan. One is to recognize that you will not be viewed the same by all lenders – so you do not have to jump at the first offer you receive. Shop around. As said, be sure to try your credit union first – and also one or more banks that have departments providing subprime lending. Try using one of the online services that allow you to apply at several lenders simultaneously, like Lending Tree
Here are a few important points for subprime borrowers to bear in mind:
Never risk valuable assets in order to make a small loan.
Avoid personal loans which involve "fancy" terms such as balloon payments. Avoid adjustable rate loans (these have proven disastrous for thousands of subprime mortgage borrowers and can be almost as disastrous for personal loan borrowers).
Always read the fine print. Be sure you understand the terms of the loan clearly. You will be held to what is in the contract, no matter how much eye-strain it takes to read it.
Do not allow several lenders to access your credit report at the same time. Several inquiries on your credit report within a short period can further lower your credit score.