Personal loans can be a valuable tool for consolidating high-interest debt, paying for a large expense, or almost any other purpose. But a personal loan with a high interest rate could lead to an unaffordable level of debt.
You’ll need good or excellent credit to get a lower interest rate, at least 670, but the higher the better. Rates vary by lender, but loan options exist for a wide range of credit scores.
It’s essential to understand how to snag a lower interest rate before you take out a personal loan.
Interest is the cost you pay a lender or creditor to borrow money. It’s usually expressed as an annual percentage called an interest rate. Interest rates vary and usually depend on your credit profile, income, and other factors.
Generally speaking, lenders charge interest on your balance until you pay it off completely. As such, the goal of any borrower is to find the lowest interest rate possible to minimize the interest you’ll pay on top of your original loan amount.
Fees are another factor adding to the cost of a loan or credit product. If you want to know the true cost of borrowing money, refer to a loan’s annual percentage rate (APR), which includes both the interest rate and fees associated with the loan.
Many consumers who need money prefer personal loans over credit cards, as their interest rates tend to be significantly lower. According to the most recent Federal Reserve data, the average interest rate for a 24-month personal loan is 11.48%, while the average interest rate for credit cards is 20.92%.
You’ll likely need a credit score that falls in the good or higher credit-score ranges to qualify for a low-interest personal loan. Here’s how the FICO credit score ranges break down:
If your credit score isn’t where you’d like it to be, try to improve your credit before applying for a low-interest personal loan. Even improving your score from fair to good may result in a lower interest rate that could save you hundreds or thousands of dollars over the life of a loan.
Related: Learn more about getting a personal loan
Generally, higher credit scores translate to lower interest rates. Fortunately, some lenders specialize in loans for borrowers with lower credit scores. Keep in mind, however, you’ll likely pay a higher interest rate for this type of loan than you would with a higher credit score.
If your credit makes it difficult to obtain a new loan, consider enlisting a close friend or relative with strong credit to cosign for the loan. A creditworthy cosigner can improve your odds of approval for a personal loan and with more favorable terms. Remember, your cosigner is responsible for repaying the loan if you fail to make your payments.
If you need cash to address a financial emergency, be mindful of predatory lenders. For example, you may see offers for payday, pawn shop, and car title loans typically aimed at borrowers with poor credit.
While these types of loans are easy to qualify for, they typically come with staggeringly high costs. According to the Consumer Financial Protection Bureau, the fee structure with a typical two-week payday loan is equivalent to an APR of nearly 400%. Only consider these types of loans as a last resort due to their whopping costs and the potential to get stuck in a cycle of debt.
You may save money in interest charges by taking steps to improve your credit score before you apply for a new loan. Here’s how:
Deciding whether or not you should take out a personal loan depends on your goals and unique financial circumstances. Of course, you’ll want to get the lowest interest rate possible, but there are other factors you should weigh, such as:
Related: Learn more about getting a personal loan