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Personal Loans - What You Need To Know

Personal loans are pretty basic. You borrow money and pay it back over time, plus interest. Personal loans are unsecured and are growing in popularity due to their flexibility and predictability. Choosing to borrow money is a big decision, though, and you should not take it lightly. If you're thinking about applying for a personal loan, here are a few things you need know.

Personal loans are general purpose. The lender isn't going to dictate the use of the money, and you can spend the cash at your discretion. Common uses include home improvements, debt consolidation, or just covering an unexpected expense, but these are just examples. You can do whatever you want with the money. Just remember that freedom brings responsibility. If you're consistently borrowing money just to keep afloat, you may need a change in financial habits, not more debt!

Keep in mind: No two lenders are the same. Interest rates may differ significantly from lender to lender. No matter how you intend to use the money, always shop around.

Where Do You Apply?
Banks, credit unions, and online lenders are some of your options. Your first stop is likely to be your bank. It will be easier to get approval from a bank where you already have an account or two. Even if your bank offers a reasonable deal, though, it's good to get a few other quotes to compare.

Even though you can do whatever you please with the money, the lender will probably inquire about your intended use. Don't be too concerned about this. This interest may only be to check if there's a better option that would fit your needs.

How Do You Apply?
First, shop around! Inquire about a personal loan with a few financial institutions. Check out the terms and interest rates each lender offers and choose the one that best fits your needs.

A personal loan application will require a few documents. These items are what you should have on hand:

Identification – Your Driver's license or state ID should do, but there's no harm in taking your passport or Social Security card along for the ride. Most lenders don't ask for two forms of identification.

Proof of Address – A copy of your lease (if you rent), utility bills, and recent mail typically work.

Proof of Income – W-2 forms, tax returns, pay stubs, and bank statements.

Expect the financial institution to ask you for other information. They'll want to know your Social Security number, monthly expenses, gross income, where you work, your date of birth, mother's maiden name, and all your contact information, including current and past addresses.

After you've provided all of this information, they'll ask the magic question: how much money do you want? Terms typically range from one to five years (sometimes seven years), but the amount of cash you're borrowing will affect that. The lender will conduct a credit check on you to obtain your credit score. Your score tells the bank how risky it is to lend you money, and the bank bases your interest rate on that risk assessment. The lower your credit score, the higher your interest rate will be.

Will You Be Approved?
Your credit score, credit history, personal income, and the amount you want to borrow will determine your chances of being approved. If your credit history is clean as a whistle, you should be fine. If you're getting daily calls from collection agencies, you might be out of luck.

Can You Improve Your Chances?
If you've kept up to date with all your bills and you don't constantly kill your credit cards, you should be fine. If you've been rejected or the interest rate you were offered was sky high, the first thing you should do is improve your credit score!

Keep your credit utilization ratio low. If you've got a credit card with a limit of $5,000 and a balance of $2,500, your credit utilization ratio is 50%. That's bad. Anything above a 30% utilization ratio is going to have a negative impact on your credit score. If you want to improve your credit, 30% or less is great, but 10% is golden.

Your utilization ratio considers your total credit. For example, let's say you have two credit cards, both with $5,000 limits. That means your available credit is $10,000. If you have a balance of $1,000 on one card, and $1,500 on the other, the total amount of credit you're utilizing is $2,500. That's a credit utilization ratio of 25%, which is good.

Pay all your bills in full and on time. Late payments hurt your credit. Improvement won't happen overnight, but it will happen. On-time bill payment is the single most important factor in your credit score. It helps to use some smarts when paying bills. If you have cash to pay your electric bill, don't use it. Use your credit card, and then use the cash to pay your credit card bill on time. You've just gotten points for paying two bills on time, with the same amount of money!

If your credit is bad and the bank is simply denying you (or the employees lock the doors and pretend to be on vacation when you pop by), you might want to consider getting a co-signer. Your co-signer will need amazing credit as he or she will become financially responsible for your debt if you default.

Be realistic about how much you want to borrow. If the bank thinks you're looking for cash beyond your repayment power, be prepared for a big red "denied" stamp on that application form.