A personal loan is a money you borrow for just about any purpose, including debt consolidation, an unexpected medical bill, a new appliance, a vacation, or even a student loan. You pay the money back including interest in monthly installments over time, usually two to five years, most personal loans are unsecured, meaning they are not backed by collateral.
The interest you pay is expressed as an annual percentage rate (APR). The average APR on a personal loan is 9.41% as of June 2019, but it can range from 6% to 36% depending on your creditworthiness, including an examination of your income, debts, and credit score.
How to Qualify for a Personal Loan
There are many steps to take to qualify for a personal loan, with the first being to make sure that it’s right for you. For example, if you want to borrow money to remodel your house or buy a car, a home equity loan or an auto loan may come with a lower interest rate.
Unlike unsecured personal loans based solely on your creditworthiness, these loans are secured by the home you want to fix up or the car you want to buy.
Although paying for a family vacation or consolidating debt fits into the personal loan category, you may also want to check into a 0% introductory APR credit card. If you go that route, however, be sure that you can pay off the balance before the 0% rate expires.
Decide How Much to Borrow
Remember that when you borrow money, you don’t just pay back the original loan. Except for that 0% card, paid off on time, you also pay interest or “rent” on the money you borrow. There’s no reason to pay interest on the money you don’t need, so only borrow what is necessary. On the other hand, if you borrow less than you need, you may be forced to turn to more expensive loan sources at the last minute.
Finally, make sure you can afford the payments on the amount you do borrow. There’s nothing worse than overextending yourself financially if the best thing would have been to wait a while until your finances improve.
5 Personal Loan Requirements To Know Before Applying
Personal loan requirements vary by lender, but there are a few considerations like credit score and income that financial institutions always look at when reviewing applicants.
Before you start shopping for a loan, familiarize yourself with the common qualifications you’ll need to meet and the documentation you’ll need to provide. This knowledge can help streamline the application process and may improve your chances of qualifying.
Here are five common requirements that financial institutions look at when evaluating loan applications.
1. Credit Score and History
An applicant’s credit score is one of the most important factors a lender considers when evaluating a loan application. Credit scores range from 300 to 850 and are based on factors like payment history, amount of outstanding debt, and length of credit history.
Many lenders require applicants to have a minimum score of around 600 to qualify, but some lenders will lend to applicants without any credit history at all.
Lenders impose income requirements on borrowers to ensure they have the means to repay a new loan. Minimum income requirements vary by lender. For example, Sofi imposes a minimum salary requirement of $45,000 per year; Avant’s annual income minimum requirement is just $20,000. Don’t be surprised, however, if your lender doesn’t disclose minimum income requirements. Many don’t.
Evidence of income may include recent tax returns, monthly bank statements, pay stubs, and signed letters from employers; self-employed applicants can provide tax returns or bank deposits.
3. Debt-to-income Ratio
The debt-to-income ratio (DTI) is expressed as a percentage and represents the portion of a borrower’s gross monthly income that goes toward her monthly debt service. Lenders use DTI to predict a prospective borrower’s ability to make payments on new and current debt.
For that reason, a DTI less than 36% is ideal, though some lenders will approve a highly qualified applicant with a ratio up to 50%.
If you’re applying for a secured personal loan, your lender will require you to pledge valuable assets—or collateral. In the case of loans for homes or vehicles, the collateral is typically related to the underlying purpose of the loan.
However, secured personal loans can also be collateralized by other valuable assets, including cash accounts, investment accounts, real estate, and collectibles like coins or precious metals.
If you fall behind on your payments or default on your loan, the lender can repossess the collateral to recoup the remaining loan balance.
5. Origination Fee
Though not part of the qualification process, many lenders require borrowers to pay personal loan origination fees to cover the costs of processing applications, running credit checks, and closing.
These fees usually range between 1% and 8% of the total loan amount, depending on factors like the applicant’s credit score and loan amount. Some lenders collect origination fees as cash at closing, while others finance them as part of the loan amount or subtract them from the total loan amount disbursed at closing.
Typical Personal Loan Documents
When it’s time to formally apply for a personal loan, your lender will request a number of documents to confirm everything from your identity to your residence and employment. Here are the most common documents lenders require as part of the personal loan application process.
A loan application is a formal document that lenders require prospective borrowers to complete and submit to begin the lending process. Each lender has its own application, so the specific requirements may vary. In general, though, you’ll need to provide basic personal information, how much you want to borrow, and the purpose of the loan.
The format of a loan application may also vary by lender. While there are numerous online lenders that offer a completely online application experience, others may need to discuss your application over the phone before providing a decision. There are also a number of brick-and-mortar banks and financial institutions that require applicants to submit a paper application in person.
Proof of Identity
Most lenders require applicants to provide at least two forms of government-issued identification to prove they are at least 18 years old and a United States citizen. This precaution also reduces the threat of identity theft. Acceptable forms of government-issued identification often include:
- Driver’s license
- Other state-issued ID
- Certificate of citizenship
- Birth certificate
- Military ID
Employer and Income Verification
A lender wants to see that you have the ability to pay back your current debts as well as the new loan. To do this, lenders typically require prospective borrowers to demonstrate their employment history and current earnings as part of the application process. Common forms of income verification for traditional employment include:
- W-2s and 1099s
- Bank statements
- Employer contact information
Prospective borrowers who are self-employed must instead rely on bank statements, 1099 forms, and income tax returns.
Proof of Address
In addition to confirming your employment, most lenders want to know that you have a stable living situation. This may involve providing proof of your address, including a recent utility bill, a copy of your lease or other rental agreement, voter registration card, or proof of home, rental, or auto insurance that lists your address.
Check Out the Details
Now that you know you are prequalified, it’s time to prequalify the lender. Go through information and disclosures in your preapproval letter and revisit the website to look for the following:
- Expected Loan Amount, APR, Monthly Payment, and Loan Term. It may or may not be exact, but it will give you something with which to compare other preapproved loans.
- Fees and Penalties. Will this loan have an origination fee? If so, how much? What are the penalties or fees for late or missed payments? Are there any other charges?
- Type of Interest. Is the interest rate fixed or variable? Do I have a choice, and, if so, what’s the difference in rates?
- Unsecured or secured. Will this be an unsecured or secured loan? For a secured loan, what is required collateral?
- Automatic Withdrawal. Are automatic withdrawals of monthly payments mandatory or optional? If optional, will I get a lower interest rate if I agree to automatic withdrawals?
- Arbitration. In the event of a conflict, is arbitration mandatory, or can I take the lender to court?
- Prepayment Penalty. If I pay my loan off early, will I pay a penalty?
- Fine Print. There’s always fine print, even in preapproval letters. Look for anything not answered above or anything you hadn’t thought of.
How to Get a Personal Loan?
You can often complete personal loan applications online, and a decision may be available as soon as the same day. However, there are a few things you should do before you even fill out the application. If you’re ready to apply for a personal loan, consider these steps before beginning the process:
- Check your credit score
- Take steps to improve your score by checking for inaccuracies and paying down debt
- Decide how much you want to borrow
- Use lender prequalification to shop around for competitive rates
- Submit a formal loan application
What Are the Different Types of Personal Loans?
The different types of personal loans are:
- Debt-consolidation loan: rolls multiple debts into one new loan
- Co-signer loan: a loan you need a co-signer to qualify for
- Secured and unsecured loans (unsecured are more common)
- Fixed and variable rate loans (fixed are more common)
Where Can You Find a Personal Loan?
You can find a personal loan in the following places:
- Your bank or credit union
- A peer-to-peer lending site
- An online loan provider
- A referral from a friend or family member
- A private loan from an investor
Can You Get Pre-Qualified for a Personal Loan?
Yes, you can usually get pre-qualified for a personal loan within a few minutes online. You fill out some personal information such as how big of a loan you need, your income, address, and other considerations.
You can see which loans you are likely to qualify for and then compare them for the best rates and terms. Keep in mind that a pre-qualification means that you’re likely to qualify for the loan, but it is not a guarantee.
Are Personal Loans Secured?
Personal loans are typically not secured. This means that you don’t need collateral such as your house or car to secure the loan. Instead, you receive the loan based on your financial history, including your Fico score, your income, and any other lender requirements you must meet.
What Should You Do If You’re Denied?
A lender can deny your personal loan application for a number of reasons. Your credit score may be too low or your DTI could be too high. It’s also possible that you asked to borrow more money than the bank thinks you can repay based on factors like income, employment stability, and other outstanding debts.
If a lender denies your personal loan application, there are a few steps you can take to improve your chances of getting a loan in the future:
- Ask for the specific reason your application was rejected
- Review your loan application for mistakes or inaccuracies
- Improve your credit score by paying down your current outstanding debts
- Check for mistakes on your credit report
- Increase your income
- Compare lender requirements
- Apply for a smaller loan amount
- Consider using a co-signer