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How Do Holiday Loans Work?

By: Ryan Olson, Chief Lending Officer

Posted on 12/8/2022 7:04:46 AM

Family of four put the star on top of their Christmas tree.

The holidays are quickly approaching and that usually means one thing for many people: spending money. Whether you're buying gifts for loved ones or traveling to see family, the costs can add up quickly. If you're not careful, you might find yourself in a financial bind come January. One option to help cover those extra costs is a holiday loan. But what are they and how do they work? Keep reading to learn more.

What is a Holiday Loan?

A holiday loan is a type of personal loan designed to help cover holiday-related expenses—from gifts and travel to decor and food. Holiday loans are usually unsecured, meaning you don't have to put up any collateral like your home or car, but they also typically have higher interest rates than secured loans. That said, they usually have lower rates than credit cards or lines of credit. Banks, credit unions, and online lenders all typically offer their own holiday loans with different terms and amounts, depending on the institution.

How They Work and How They Can Be Beneficial

When you take out a holiday loan, you agree to a fixed interest rate, fixed monthly payment, and set loan term. This means that your interest rate and monthly payment will not change over the life of the loan, and you will have a set amount of time to pay it off. Having this vital information will help you budget each month and avoid any unexpected surprises.

Some lenders may charge an upfront origination fee, which is usually a percentage of the loan amount. But this fee is typically factored into your monthly payments so that you don't have to pay it out of pocket.

The loans are typically only available the last few months of the year, meaning you won't be tempted to use the money for other purposes. They are also usually lower-dollar amounts, ranging anywhere from $1,500 - $5,000. Interest rates vary from 7.99% to 13.99%, which is still generally lower than credit card/line of credit rates. Your specific loan amount and interest rate will vary by institution, but they will typically fall in the aforementioned ranges.

Holiday Loan Requirements

The requirements for a holiday loan may vary slightly depending on the lender. Generally, you will need a minimum credit score of 670 (good or excellent credit) to qualify at a bank; this will also get you the most favorable rates. Those with fair or bad credit might consider holiday loans from credit unions for the best rates, as they can consider other factors besides just your credit score. Online lenders can offer holiday loans for the whole spectrum of credit scores, but they can have higher maximum annual percentage rates (APRs) for poor or bad credit borrowers. Across the board though, you will typically need to meet a certain credit threshold, have verifiable and consistent monthly income, and a debt-to-income (DTI) ratio of 36% or less.

The Different Types of Holiday Loans Available

  1. Unsecured Personal Loan – An unsecured loan is a type of personal loan that does not require collateral, so it's less risky for you. The interest rate is usually higher than a secured loan and the repayment term is shorter.
  2. Secured Personal Loan - A secured loan requires collateral, such as your home or car. The interest rate is typically lower than an unsecured loan and the repayment term can be longer. But, if you default on the loan, your collateral may be subject to repossession.
  3. Line of Credit - A line of credit is a flexible loan option, meaning you can borrow and pay back as much money as you need. You will only be charged interest on the amount of money you use, and repayment terms are more flexible than other types of loans. However, lines of credit have higher APRs than most personal loans and can come with more fees.
  4. Installment Loans - An installment loan is a lump sum of money that you borrow at once and pay off in regular monthly payments over the term of the loan. They are typically used for larger purchases, such as home renovations or even car loans, and can be in weekly, biweekly, or monthly installments.
  5. Credit Cards - Credit cards can be a good option for holiday shopping if you know how to use them responsibly. They offer the convenience of having immediate access to funds and allow you to pay off the balance in installments or all at once. However, credit cards have higher interest rates than most personal loans and can lead to debt quickly.
  6. Payday Loans - Payday loans are short-term, high-interest loan products that are meant to be paid back on your next payday. However, they often have extreme interest rates and can lead to a cycle of debt if you don't pay them off quickly. It is important to be extremely cautious with these types of loans and to generally avoid them due to predatory lenders and their tendency to balloon into excess debt.

Person holds calculator while adding up the cost of wrapped presents.

How to Choose the Right Loan for You

Choosing the right loan for your holiday season can be tricky. Evaluate your finances and consider what type of loan best fits your needs. Make sure to shop around—research different lenders; compare rates, terms, and fees; and read reviews to help you make an informed decision. Remember, it is important to pay off debt as quickly as possible to avoid accruing interest, so really look at your budget and ensure you can comfortably make the monthly payments if you put expenses on a credit card. You can also look for a credit card with a 0% introductory APR to help you save on interest. Finally, be sure to thoroughly read the terms and conditions of any loan before signing.

The Repayment Process and What to Expect

Once you have chosen a loan, the repayment process typically involves making regularly scheduled payments over a period of time, usually between 12 – 60 months. Depending on the lender and the type of loan you choose, repayments may be made in full or interest-only installments. Make sure to stay up to date with your account and make timely payments as agreed upon with your lender.

Some lenders may offer early repayment discounts or penalties, so it's helpful to know these terms. Moreover, you should know exactly when your payments are due, so you can budget accordingly. Setting up autopay is a great way to avoid missing a payment. And if you do find yourself in a bind, most lenders offer extensions or payment plans to help you get back on track.

Things to Consider

When you're strapped for cash, holiday loans can be a great option to help fund your holiday expenses. Most lenders offer short repayment terms and lower interest rates than regular unsecured personal loans. Plus, many lenders offer interest-only payments or discounts for early repayment, so you can save money on interest. The low-dollar amount of holiday loans also means you're not borrowing more than you need and you can repay it with ease with the proper planning in place.

Having said that, remember taking out a loan to cover holiday costs means you're paying for the goods plus interest. You will end up paying a higher amount than the actual cost of your holiday expenses. Additionally, your credit score could take a hit if you miss a payment, make a late payment, or default on your loan. This is why it's incredibly important to evaluate your financial situation and ensure you can afford the monthly payments.

Alternatives to Holiday Loans

Special Holiday Savings Account

Consider setting aside a small portion of your paycheck each month in a special holiday savings account. Some banks and credit unions offer these accounts for the explicit purpose of holiday shopping, and you can usually withdraw the money at any time. This is a great option to have a dedicated place to store your holiday money, separate from your everyday accounts, where you can hold yourself accountable and stick to a certain spending limit.

Saving Early

Time is your friend when it comes to saving money. The earlier in the year you can start setting a little aside, the more you'll have once the holidays roll around. This makes saving more manageable without having to sacrifice too much.

Spread Out Buying Gifts Throughout the Year

If you want to avoid the holiday rush and the added expenses, consider spreading out your gift buying. Instead of doing all of your shopping in December, try getting gifts throughout the year when they're on sale or clearance. This way, you can stretch your budget without having to resort to a loan.

Cash Back Credit Cards

If you want to put your holiday expenses on a card, look for one that pays cash back or offers rewards. This way, you can make purchases and get something in return. Just be sure to pay off the balance in full each month so you don't incur any interest charges.

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