There may come a time when you need some cash. And we're not talking about pocket change, but something more substantial. Maybe a series of crises caused you to run through your emergency fund or at tax time you're faced with writing a big check instead of getting one back. You also may have seen the equity in your home evaporate or had your credit card limits frozen or lowered.
An emergency fund
It's not a matter of if the financial emergency will occur, but when. Prepare for the inevitable by socking away some funds every week.
Although this is sometimes easier said than done, you should make it a priority in your personal financial plan. We recommend your emergency fund contain three to six months of your committed expenses and that it be housed in a safe place such as a savings or money market account. Why? Because you never know when you might need it and return of principal is more important than return on principal.
If you've exhausted most of your options to drum up some dough, it could be time to explore the world of personal loans. No, I'm not talking about hitting up friends or family when faced with a financial tight spot. The personal loans I'm referring to are offered by banks, credit unions or even credit card companies.
How do they work?
Similar to a credit card, this type of loan is normally unsecured. So, unlike a home or auto loan, there is no collateral. The lender is making the loan based solely on his or her belief that you'll live up to your end of the deal and not leave them out in the cold. For that reason, you may hear this type of loan referred to as a signature loan. A signature is all it takes. Of course, that's not really the whole truth. Your credit score and history, along with other criteria, will determine if you can get a personal loan and at what interest rate.
As far as interest rates go, this type of loan will normally fall somewhere in between secured loans, like a car loan or mortgage, and those dangerously high double-digit rates sometimes found with credit cards, retail store cards or credit card cash advances.
While there's no collateral, the repayment terms of a personal loan will more closely resemble those of an auto loan. Typically, you'll have a set repayment period of four or five years and a fixed interest rate. For example, a four-year $15,000 loan at 12 percent would require 48 payments of $395. There's no flexibility on this front, the payment is what it is. While a fixed payment schedule might seem daunting, it also can provide some certainty when it comes to budgeting or a debt elimination plan. With this type of loan, the terms and loan amount are set and fixed from the start.
When to use one
Now that you know how personal loans work, you may be wondering when it makes sense to use one. Here are a couple of ideas:
- Debt consolidation. If you're looking for a way to pay down sky-high interest credit card debt, a personal loan could work, as long as you've corrected the behavior that caused that debt in the first place. A personal loan is a tool that may allow you to execute a debt elimination plan with a set monthly payment that has a beginning, and most importantly, an end.
- Paying for the unexpected. Unforeseen expenses or opportunities also can be addressed with a personal loan. Granted, in my mind an emergency fund would work better, but maybe you're just getting yours going when you're hit with a financial challenge. If that's the case, a personal loan may work well.
Personal loans are a fairly simple and straightforward way to borrow, and you can use the money any way you like with no strings attached.
Note: This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.