Loans are a valuable financial tool that helps consumers afford costly purchases and unexpected emergencies. In fact, more than 20 million Americans currently have personal loans.1
If you need quick cash, know that there are loan options for almost every financial situation. For example, you could apply for bad credit loans if you have low credit.
If you have never taken out a loan, you may wonder what you need to apply for one. Keep reading to learn about the different types of loans available and how to start the approval process.
What Are the 3 Types of Loans Available?
When looking for a loan, it’s critical to know about the different options available. Loans fall into three categories based on how they are repaid. The best loan depends on how you prefer to make payments and how long you want to pay off your borrowed money.
- Single-Payment Loans — A single-payment loan is a kind of loan that borrowers repay in one lump sum. Many borrowers use payday loans or cash advance loans.
- Installment Loans — An installment loan, such as a personal loan, is paid off in monthly payments. The repayment length depends on the financial institution you work with and the type of loan you get. However, repayment lengths can range from a few months to a couple of years.
- Revolving Credit Loans — A revolving credit loan allows borrowers to borrow money, pay it back, and then borrow again. Borrowers receive a credit limit based on their credit history and income and can spend up to that amount. Credit cards are a standard revolving credit loan option.
Secured Loan vs. Unsecured Loan: What Is the Difference?
Now that you know the three loan options available, you need to decide whether to get a secured or unsecured loan.
| Aspect | Secured Loans | Unsecured Loans |
| Collateral Required | Yes. Requires an asset as collateral, such as a home, car, or savings account. | No. Does not require any collateral. |
| Risk to Borrower | Higher risk. The borrower risks losing the collateral asset if they default. | Lower risk. No risk of losing a specific asset, though credit score may be affected. |
| Interest Rates | Generally lower, as the lender has the collateral to fall back on. | Generally higher, reflecting the increased risk to the lender. |
| Loan Amount | Often higher, as it’s based on the value of the collateral. | Usually lower compared to secured loans, based on creditworthiness. |
| Credit Requirements | May be more lenient. Collateral reduces the lender’s risk. | Usually stricter. Good to excellent credit scores are often required. |
| Loan Approval Time | Can be longer, as the collateral needs to be assessed and verified. | Often quicker, as there’s no need to evaluate collateral. |
| Typical Use | Large purchases like homes (mortgages) or cars (auto loans), business loans. | Personal loans, credit cards, student loans, small personal or emergency expenses. |
What Are the Five C’s of Credit?
When a financial institution receives a loan application, it will make a qualifying decision based on the five Cs of credit. The 5 C’s help lenders get a better understanding of someone’s creditworthiness. Suppose you want to take out a loan. In that case, it’s essential to know what factors will affect your eligibility to borrow money.
Below is more information on the five C’s of credit.
1. Character
Your character is represented by your credit score. Credit scores are a good indication of a person’s trustworthiness and credibility. When you submit a loan application, most financial institutions will pull your FICO score to make a qualifying decision.
FICO scores are made up of five factors:
- Payment History (35%)
- Total Debt (30%)
- Length of Credit History (15%)
- New Credit Inquiries (10%)
- Credit Mix (10%)
Building a high credit score can take time, but it’s easy once you know what affects scores the most. If you want to improve your poor credit score, focus on making all of your monthly payments on time and paying down your outstanding debt.
2. Cash Flow
Cash flow, also known as capacity, is your ability to adhere to the repayment terms of a financial contract. One way to measure cash flow is to analyze a person’s debt-to-income ratio. A DTI demonstrates how much of your income goes toward debt repayment. A low DTI indicates that you earn more than you owe, while a high DTI means that debt controls your income.
Add all your monthly bills to calculate your DTI ratio to get your total monthly debt amount. Then divide the total by your gross monthly income, which is the amount you earn before taxes and other deductions. The result is your debt-to-income ratio as a decimal, which you can convert to a percentage. If your monthly debt payments are $1,800 and your monthly gross income is $6,000, your debt-to-income ratio is 30%.
According to financial experts, your DTI ratio should be lower than 35%. A high DTI signifies to lenders that you are a credit risk because you have too much outstanding debt compared to your household income.
3. Capital
Capital is your level of financial contribution or the amount of money you have. Financial institutions consider your commitment to debt repayment when analyzing your credit history. Suppose you want to buy your first home. The mortgage lender will consider the size of your down payment in relation to the purchase price. If you provide a high down payment, then the lending risk is lower, and you may get a low-interest rate offer.
4. Collateral
Collateral is the personal property you provide to a financial institution to secure the loan and reduce the lending risk. Secured loans require the use of collateral, while unsecured loans do not. Secured loans can help low-credit borrowers get loan approval from a bank or credit union. Although some online lenders also offer secured loans.
These are a few examples of loan collateral:
- Car title
- Property title
- Cash in a savings account
- Investment accounts
- Machinery/equipment
Using collateral to secure a loan is risky, though. In the event of default, the lender will take possession of the asset and sell it to recoup the remaining loan amount. Carefully consider whether you are comfortable with the possibility of losing your personal property, even if you doubt you will experience financial issues during the repayment period.
5. Conditions
Conditions include the borrower’s financial situation and the economic conditions concerning the loan. Lenders evaluate a borrower’s income stability and economic factors for approval. Financial institutions will consider federal interest rates and other conditions because the state of the economy affects them as well as borrowers.
What Documents Do I Need for a Loan Application?
You will need to provide a few documents to a financial institution to get approval for a loan. You will need to bring your documents with you if you decide to apply for a loan in person at a brick and mortar.
Online and traditional loan processes are generally the same. However, online loans tend to be faster and more convenient. In fact, you may not have to provide any documentation for an online loan.
The actual documents you need will vary, but generally, you can expect a lender to require the following items:
- Photo ID: Financial institutions will require a government-issued photo ID such as a state identification card or driver’s license.
- Proof of Income: You must provide income verification to a lender to qualify for a loan. Most borrowers prove they have steady income with bank statements or paycheck stubs. Still, you might be able to use alternative income sources. For example, Social security disability loans allow consumers to use disability checks.
- Proof of Address: To prove you reside at your current address, you can typically provide a credit card statement, utility bill, lease agreement, voter registration card, etc.
- References: Some lenders may ask for a couple of personal or professional references.
- Collateral: You will have to provide documentation for collateral or the tangible object if you apply for a secured loan.
What Are the Most Common Emergency Loans?
Now that you know more about the process of taking out a loan, you may want to know how to pick the best loan for your current financial situation.
The best loan for you depends on the following factors:
- What do you need the loan for?
- How much money do you need?
- How much time do you want for repayment?
- Do you want to use collateral?
Answering these questions can help you narrow down your loan options. Once you have an idea of what loan terms you want, you can choose the type of loan you want. Below is a list of standard loans people take out in the United States to deal with financial emergencies.
Personal Loans
A personal loan is an installment loan that provides a lump sum to borrowers. Most personal loans have fixed interest rates, which means your monthly payment remains the same from start to finish. The repayment length for a personal loan varies but usually lasts a few months up to a couple of years.
Getting approved for a personal loan depends on your credit score and income. Got a bad credit score? You may still qualify to borrow money with a personal loan lender. While it’s possible to get a secured personal loan, most lenders only offer unsecured loans.
The personal loan application process is quick, so you can get a same day online loan for financial emergencies. While personal loan rates are generally decent, taking time to compare personal loan rates to find the lowest one is still a good idea.
Payday Loans
A payday loan is a short-term loan that provides small amounts of money. Payday loans tend to have high approval rates because credit is not an essential qualifying factor. All you need to qualify is a steady source of income and proof of identification. However, payday loans are notorious for being difficult to repay because borrowers typically only receive two weeks to pay off the high-interest loan.
Credit Card Cash Advance
If you already have access to a credit card, you can withdraw cash at a nearby ATM! The amount you can get through a cash advance depends on your credit card limit and issuer. Every credit card issuer has a different cash advance limit. This limit is typically less than half of your total credit limit.
Credit card cash advances can cost a lot. You are subject to a high cash advance annual percentage rate (APR) when you withdraw money. The credit card company may also issue a flat cash advance fee. And if you withdraw cash at an ATM, you will likely have to pay an upfront operator fee. Read your credit card’s terms and conditions to learn how much a cash advance will cost.
FAQs About Applying for a Personal Loan
Lenders assess your monthly income and expenses to determine your ability to repay the loan. A stable income and manageable expenses typically improve your chances of being approved for most personal loans.
Absolutely! A personal loan can be a smart way to consolidate debt. It involves using the loan to pay off multiple debts, leaving you with a single, more manageable monthly payment. This can often lead to lower interest rates and simplified finances.
Bank statements are crucial as they provide lenders with a snapshot of your financial health. They show your income stability, spending habits, and ability to manage money, all of which are key factors in a personal loan application.
Credit unions are member-owned and often offer more personalized service and potentially lower interest rates compared to traditional banks. They might also be more flexible with members who have less-than-perfect credit.
Consider your specific financial needs, your ability to comfortably manage the monthly payments, and the purpose of the loan, whether it’s for a major purchase, debt consolidation, or another expense. It’s important not to borrow more than you need or can afford to repay.
Your credit score plays a significant role in your personal loan application. It’s like a financial report card that lenders use to assess risk. A higher credit score usually means better loan terms, like lower interest rates, because it indicates you’re a responsible borrower.
Taking out a personal loan can impact your credit in several ways. Timely repayments can improve your score, while late or missed payments can harm it. Also, the initial credit check might cause a temporary small dip in your score.
Absolutely! It’s important to take a close look at your monthly expenses before applying for a personal loan. This helps you understand how much you can afford to repay each month without straining your budget. Ensure your loan repayments, along with your other expenses, don’t stretch your finances too thin.
What CreditNinja Wants You To Know About Taking Out a Personal Loan
In order to take out a loan, you typically need to provide specific information and a lot of documents. However, many online lenders do not require any paperwork!
At CreditNinja, documentation is not usually required, which means our approval process is much faster than traditional bank processes. All you have to do is complete our online application form with basic information. Inquire today to see just how easy it can be to get quick cash loans.
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