Guest Shannon McLay, CEO of The Financial Gym
The small loan gets its name from the most obvious of reasons – its size. In general, a loan that provides $3,000 or less could be called a small loan, even if it falls into another category as well. Many people use them to cover unforeseen, sudden costs, so while they often overlap with emergency loans, that’s far from being their only purpose.
Read on to find out more about the many different types of small loans, what small loans can be used for, and how you can get one of your own.
Different Types of Small Loans
The majority of small loans are personal loans, but other kinds are widely available. Here’s a look at some of the more common types.
This type of loan is typically known for the freedom the borrower has to use it for just about any reason they choose. A personal loan can be secured or unsecured, meaning there may or may not be collateral for the loan. While unsecured loans tend to have higher interest rates, in general, personal loan rates are usually lower on average than some other types of debt like those of credit cards.
Payday loans are classic emergency loans that almost always fall into the category of small loans. They can usually be obtained very quickly and the debt is typically repaid in a single payment on the next payday. But buyer beware! These loans come with very high-interest rates and fees, and for that reason, are often referred to as predatory loans.
Credit Card Loan
When you buy something or get a cash advance with a credit card and the total is $3,000 or less, you are taking out a small loan. If you have a great credit score, congratulations! This is one situation where this generally pays off with a much lower interest rate.
The rates on credit cards can vary widely, with rates in the mid-20% range being common. You could acquire many small loans every day and pay them back immediately or over many months, or even years – as long as you make the minimum monthly payment for the account as a whole. Because of the high-interest rates, consumers often use personal loans to pay off these small loans as a way of consolidating debt and saving money on interest charges.
Unless you are putting down a truckload of money for a vehicle, an auto loan would not qualify as a small loan. However, someone financing a used car or truck might be able to use a small loan as part of the repayment plan. These are usually issued as simple installment loans with fixed interest rates over several years.
For a title loan, a borrower uses the title of their car as collateral. Although you give the lender the security of handing over your car title, the loan still comes with very high-interest rates, typically around 300 percent. This type of loan should be used only in an absolute emergency situation.
Small Business Loan
Any form of business loan that doesn’t go over $3,000 could be considered a small loan. The “business loan” umbrella covers a wide range of loans, including business lines of credit, business credit cards, and merchant cash advances.
What Can I Use a Small Loan For?
Aside from auto loans, most small loans can be used for any purpose. They’re especially useful for financial emergencies like car repairs, replacing necessary appliances, or paying off medical expenses. People also use them to settle urgent debts that have higher interest rates.
Where Can I Get a Small Loan?
Online lenders and peer-to-peer lenders offer a wide range of small loans, and some online lenders even specialize in them. Some banks and credit unions offer them in the form of small personal loans, auto loans, and various business loans, but they’re usually slower in processing these than online lenders. That means a long approval time, and getting access to the money can sometimes take up to two weeks.
Who Can Qualify for a Small Loan?
The standards vary based on the type of loan and from lender to lender. If you have poor credit or no credit, there’s some good news here! Some types of small loans, particularly the ones with the highest fees and interest rates, may be available to you.
Otherwise, a borrower’s credit score is one of the most important factors in loan approval and the interest rate. Although many lenders set the minimum for loan approval at a credit score of 640, this is an area (unlike mortgages for example) where there are many options for individuals with poor credit. They’ll just have to be ready to pay higher interest rates on what they borrow.
In addition, most lenders want to see a long credit history and proof of income. Another important factor is your debt-to-income ratio (DTI). That ratio reflects the total amount of your income that goes every month to your debt payments. According to the Forbes Advisor, a DTI of 36 percent is considered ideal, but a small loan could also be taken out with a value of up to 50 percent.
As you can see, these small-but-mighty loans can be a great help to a wide variety of borrowers, including those who might be almost desperate for help and those who have their eye on a special purchase.