Basic financial education and solid money management skills are critical to the success of every adult. But not everything was included in the “adulting” handbook. For most of us, when we need access to additional cash we have a tendency to reach for a credit card. It’s usually a faster and easier route, but it’s not always the best option. Personal loans are often overlooked as an easy option. When suggested, most people find themselves asking “What do you need to get a personal loan?”
Here’s a startling fact: Research conducted by the Global Financial Literacy Excellence Center found that financial knowledge accounts for 30-40% of retirement wealth inequality. This gap translates to more elderly employees delaying retirement and more retirees in more debt.
Furthermore, Millennials show alarmingly low financial literacy levels. Financial literacy assessments focus on six major topics: interest rates, inflation, risk diversification, bond pricing, compound interest, and mortgages. Unfortunately, only 3% of millennials could correctly answer all six questions about these topics in a recent survey.
BrightUp is working to close these knowledge gaps and empower employees of all ages to achieve financial wellness and build wealth. The first step is education. So, if you’re curious about the requirements to get a loan, keep reading. Knowing how to get a personal loan when you need money in a pinch can help you avoid a financial fiasco.
How Do Personal Loans Work?
Personal loans are considered installment loans – a type of loan that allows you to borrow a certain amount of money at once. You’ll be required to pay back the loan over a fixed period of time at a fixed interest rate. These two guidelines constitute the loan terms. When you receive your money, the interest rate you agreed to will begin to build onto the amount that you owe. Essentially, you begin accruing interest and making monthly payments as soon as you receive your loan.
This differs from revolving credit – like a credit card or a personal line of credit – where the borrower has access to a certain amount of credit but only charges interest on the money used. Revolving credit also does not have an end date like a personal loan term. You can continue borrowing and paying off the money at your leisure.
Unsecured vs. Secured Personal Loans
When choosing a personal loan, you’ll need to decide between an unsecured or secured personal loan. Secured loans require that you offer up collateral if you can’t pay back your loan. In contrast, unsecured loans let you borrow money outright with the lender’s confidence that you can pay it back.
Unsecured loans are the most common personal loans and have grown in popularity in recent years. Experian reports that since 2014, individual loan balances have grown steadily, with overall debt reaching a new all-time high at $323 billion in 2020.
Why have they become so popular?
Some signs point to the rise of FinTech, which now has control of 49% of the market for new loans. The growth of this sector means more young adults are tapping into credit. Additionally, as Millennials grow older, their credit scores improve, and they access more borrowing opportunities.
If you have good credit and are looking for a personal loan, you’ll most likely end up with an unsecured loan. However, if you’re in a bind with your credit history, a secured personal loan is an excellent opportunity to help you build back your credit.
The Cost of a Personal Loan
No matter how much we wish it would, money doesn’t grow on trees. So nobody expects to take out a loan without paying the price.
When taking out a loan, you’ll need to consider more than the amount you want to borrow. Interest rates and fees can make a big difference in how much your loan will cost over the lifetime of your term. Here are the three costs to consider:
- Origination fees
- Interest rates
- Prepayment penalties
Some lenders will charge a fee to cover the cost of processing a loan – usually 1 – 6%. It’s a common charge for lenders who meet with you in person. It covers the cost of that person’s work.
Your lender may also include a disclaimer in the loan contract about prepayment penalties. A prepayment penalty is a charge you receive if you pay off your loan earlier than the agreed-upon term. The faster you pay off a loan, the less interest you have to pay. Lenders protect themselves from losses on unpaid interest with the prepayment penalty.
When choosing a personal loan, the offered interest rate should get the most attention. Interest rates can range from 5% for borrowers with excellent credit to 36% for those with subprime credit. The lower your interest rate, the less money you’ll have to pay.
Before signing the dotted line, calculate all of the costs associated with the loan, not just your interest rate. Again, these include:
- Prepayment penalties
- Origination fees
- Processing fees
Personal Loans vs. Other Options
Now that you understand how personal loans work, it should be easier to compare them to other lending options. It’s clear they’re a great option to access cash for various situations, but are the terms ideal for your financial needs?
Credit Cards
One of the most common sources of credit that people choose to access is credit cards – primarily because they’re easier to acquire. However, a credit card varies from a regular personal loan in how the credit card holder uses and pays off the money. With a personal loan, or amortized loan, the borrower pays scheduled, periodic payments to the loan’s principal amount and the interest accrued. The borrower uses revolving credit with a credit card, which means you borrow against an established credit limit. In addition, the credit card does not have set payment amounts – just a minimum. Without a specific plan for the pay-off, many credit card users find themselves in more debt than they started with.
Home Equity
Home equity is another source of credit you may consider if you own your home. You could easily qualify for other credit options like a credit card with a 0% introductory rate if you have good credit. If you own a home, you could also take out a Home Equity Loan or Line of Credit to access large loan amounts for low rates. Take the time to explore all of the options available to you.
Payday or Emergency Loans
If you have bad credit, a secured personal loan could still be a good option for you to access cash and build your credit. There are also low-amount Payday loans or Emergency loans available for borrowers with low credit scores. However, payday loans can be a dangerous way to snowball your debt.
When it comes to covering emergency expenses or recovering from expensive debts, a personal loan will likely be the most responsible choice. If you’re sure a personal loan is the right choice for you, let’s look at taking the next step: the application and qualification process.
4 Common Loan Application Requirements
So what does it take to get a personal loan? There are four main requirements.
Almost every loan application will require specific pieces of information that provide insight into your current financial standing. Before you start shopping for a loan, you’ll want to familiarize yourself with these qualifications so you can be prepared to provide the appropriate documentation. In addition, learning more about these elements could improve your chances of qualifying.
The four areas of interest include:
- Credit score and history
- Income
- Debt-to-Income Ratio
- Collateral
Together, these elements paint a picture of your ability to pay back the money you’re asking to borrow.
1. Credit Score and History
When learning about personal loans, there are many terms that get thrown around: credit score, credit history, credit report, and more. While they’re all closely related, they’re not entirely interchangeable.
So how are they different?
Lenders will pull a credit report when a loan application is submitted. Two of the most critical pieces of information in the credit report are your credit score and your credit history.
A credit score is a rating the credit bureau will give you as a borrower. They range from 300 to 850 and are calculated with factors including your payment history, outstanding debts, and length of credit history. Your credit history measures how long you have managed various lines of credit. Your payment history tracks whether or not you missed any payments during that time.
Most lenders require a minimum score of 600 to qualify for a loan. In 2020, a BankRate survey revealed 21% of U.S. consumers have had an application rejected because of a low credit score. However, some lenders offer more flexible requirements for borrowers with bad credit. For example, BrightUp offers compassionate capital in the form of an emergency Loan. This option doesn’t have a minimum credit score requirement. We also provide a Debt Consolidation and Refinance program that uses alternative underwriting to expand access to affordable rates. While bad credit lenders are harder to find, they do exist.
2. Income
Before accepting your application, a lender needs to feel confident that you have enough steady income to repay your loan. Even if you have a great credit score, you’re less likely to get approved if you’re in between jobs or are asking for more money than you can afford to pay back. The minimum income requirements to get a personal loan will vary by lender and by loan amount.
You can prove your income with recent tax statements, bank statements, pay stubs, or a signed letter from your employer. If you’re self-employed, you would be required to provide your tax returns and bank deposits.
3. Debt-to-Income Ratio
Even if you have an excellent credit score and a healthy salary, lenders won’t necessarily accept your loan. For example, suppose you’ve already taken on large debts. In that case, there could be some concern about your ability to make any additional payments each month. Your debt-to-income ratio is the percentage of your monthly income that is already designated as payment for pre-existing debts.
While lenders may have different debt-to-income ratio requirements, you’re in the safe territory if your ratio is 36% or less.
4. Collateral
Not every personal loan requires collateral, but some borrowers may need to leverage collateral when applying for a loan. If you need to get a secured personal loan, you’ll be required to pledge valuable assets collateral—for example, your car, home, or savings account. Collateral protects the lender if you fall behind on your payments or default on your loan. The lender will repossess the collateral to cover the remaining balance on your loan.
About the Loan Application
Requirements for a loan may vary from lender to lender. Some lenders are willing to work with applicants with lower credit scores. In contrast, others have minimum requirements that shut many borrowers out. However, the loan application and review process is similar for most lenders.
To prove your creditworthiness based on the considerations above, you will need to provide high-level personal information and official documentation.
Proof of Identity
To qualify for a loan, you need to prove that you are at least 18 years old and a citizen of the United States.This is one of the first lines of defense against identity theft in lending. Examples of acceptable forms of identification include:
- Driver’s license
- State-issued ID
- Passport
- Birth Certificate
- Military ID
- Certificate of citizenship
Proof of Address
Like credit unions and community banks, some lenders require that borrowers live within a specified service footprint. For others, they need your location information so they can mail any bills or paperwork to you. You can provide proof of address with a piece of mail, a recent utility bill, your rental agreement, or a voter registration card.
Employment and Income Verification
We already know income is one of the main factors in getting a personal loan. In fact, it may be the most critical part of the application process. The lender will want to make sure you can pay back your current debts and the new loan. You may need to provide a detailed employment history beyond your current role. You can confirm your income and employment in the following ways:
- Paystubs
- Tax returns
- W2 or 1099
- Bank statements
- Employer Contact
Beyond your employment income, a few other types of income to consider including are rental property income, Social Security benefits, pension, and foster care payment. Again, make sure you provide a complete picture of your income to better your chances of getting approved.
Here are a few more tips for putting together a loan application packet before applying.
Loan Terms
Loan terms are the terms and conditions involved in borrowing money. They include the loan’s repayment period, interest rates and associated fees, penalty fees, and any other special condition that may apply.
When you apply for your personal loan, some lenders will ask you to state how much money you want to borrow, the length of term you want, and the purpose of the loan. You can use tools like this personal loan calculator to determine the best ask for your financial situation.
While it may be intimidating, keep in mind that you can negotiate when applying for a loan. For example, you may be able to counter the initial loan period offered. If you need smaller monthly payments, you can ask for a longer term. After all, the lender will earn more on interest with a longer term. You can also negotiate your APR, fees, and monthly payment amount. Don’t be afraid to advocate for yourself and protect yourself financially. Learn how to calculate how long you should take to pay off a loan.
What Happens if You Can’t Get a Personal Loan Approval?
Don’t give up yet.
It’s easy to start panicking. But remember, you’re amongst 21% of U.S. consumers who have been denied a credit application. With all the knowledge you’ve gathered about personal loans and how lenders review your application, you’ll probably have a pretty good idea about what went wrong. Use that knowledge to empower you to continue searching. Take a deep breath and focus on what it will feel like when you’re finally out from under the pressures of debt.
Widen Your Search
If you went with a bank for your personal loan, it’s easy to understand why they may have denied you. Banks, especially large commercial banks, tend to have more rigorous requirements. As for-profit institutions, they’ll alway focus on your credit risk to ensure they can make a profit on the deal.
We’ve highlighted some great alternative options for a traditional lender in our overview about the best way to get a loan. Some additional sources to consider include:
- Community banks
- Credit unions
- Online lenders
- Payday Lenders
- Finance Companies
You can even ask your employer if they know of any financial wellness benefit programs that could provide you with the support you need.
Work on Your Financial Standing
If the loan isn’t for an emergency, you may want to take a little time to improve your financial status. Improving your credit score, paying off other debts, and looking for additional sources of income could position you as a more appealing borrower. Here are a few tips for each!
Seven ways to improve your credit score:
- Review your credit report
- Pay bills on-time
- Avoid using your credit card
- Pay down other debts
- Limit additional requests for credit
- Consider consolidating your debt
- Contest any mistakes on your report
Paying down your debts not only improves your credit score, but will also reduce your debt-to-income ratio. Another way to fix your ratio is to find additional sources of income. For example, can you turn your passion into a side hustle? Can you get a part-time job that isn’t too stressful on your schedule? If you find more creative ways to get cash, you may find you no longer need the personal loan!
Working on your financial status may feel like a big challenge, but helpful tools can make the process easier. Many financial management apps can help you with tasks like budget planning, goal setting, and tracking your debt-to-income ratio.
BrightUp is Here to Help
The team at BrightUp works hard to provide helpful financial planning tools and personalized financial education to empower employees of all ages to take hold of their finances. Because everyone deserves the chance to build personal wealth. We also offer compassionate capital for those who are struggling to find a source of credit to cover emergency expenses or recover from expensive debts.
If you’d like to learn more about how we can help your company, let us know! You can contact a BrightUp representative today.
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