Do your homework on holiday loans
The holiday season doesn’t come cheap.
This year, Americans are forecast to spend more than $1,000 on gifts, travel, food and clothing.
This isn’t a small sum, especially since two in five people say they can’t cover a $400 emergency.
It’s little surprise, then, that many people turn to debt to finance their holiday cheer. Those who prefer a predictable payment schedule and want to avoid the high interest that comes with credit cards are turning to holiday loans, which are unsecured personal loans in small amounts.
These have become increasingly popular in the last four years, with the largest share of new loans handed out in the fourth quarter, according to TransUnion. The volume of new loans of less than $2,500 increases markedly in November and December versus September and October, according to Experian data.
What is a holiday loan?
Holiday loans typically come with a fixed interest rate and installment repayment plan that starts as soon as the loan funds are distributed. The loan amount generally ranges between $500 and $5,000, with terms between a year and five years. Funds can be used for any purpose.
You often can apply for these loans online, and some require no credit check before approval. Banks, online lenders and credit unions all offer personal loans.
“It’s not unusual for credit unions to advertise a special holiday loan which has a low rate that is only available on Black Friday or for a set time,” said Mike Schenk, chief economist of the Credit Union National Association.
Key factors to consider
Don’t take the first offer you see. It’s important to compare different features, because not all holiday loans are the same. “Shop around for a loan as aggressively as you would a holiday flight,” said Brian Karim- zad, vice president of research at LendingTree.
Rate: The interest rate on personal loans often are lower than what you pay on your credit cards. That means if you must finance your holiday spending, a loan may be the cheaper way to do it. To get the lowest rates, you must have a good-to-excellent credit score, usually 680 or higher.
Fees: Don’t forget to factor in any upfront fees, which often is calculated as a percentage of the amount you borrow. Typical origination fees range from 1 percent to 5 percent of the total amount.
APR: The best way to compare loan offers is to look at the annual percentage rate, or APR. This factors in both the interest rate and any fees you must pay, so it’s a more accurate reflection of the cost of the loan.
Prepayment penalty: If part of your payback plan is to use your tax refund to eliminate the debt early, make sure there are no penalties for prepaying the loan.
Who should get one?
To get the best rates, you must have credit between 680 and 850. You also should have low monthly debt payments relative to your monthly income. If that ratio is too high, you may be rejected for a loan.
Before taking a loan, make a list of your expected spending for the holiday season. Don’t borrow more than you expect to need. If you can’t stay financially disciplined, skip the loan.
“If you’re chronically in debt, if you haven’t been able to pay off your credit card for three months or more in the last year, you need to get that in control first,” Karimzad said.
“You should think about scaling back your spending for the holidays.”