The pros and cons of personal loans
If you need the extra cash to pay for home renovations, finance a wedding, or consolidate high-interest debt, you might consider a personal loan. Used wisely, an unsecured personal loan can fill a gap in your budget without risking your home or other property.
As with other loans, personal loan rates depend on your credit rating, income, and debt-to-income ratio, and they are not the right choice for everyone. Consider these advantages and disadvantages of personal loans before making a decision.
What is a personal loan and how does it work?
A personal loan is a type of installment loan that gives you a fixed amount of money, often between $ 1,000 and $ 50,000, in a single payment. Personal loans are generally unsecured, which means you don’t have to use collateral to secure funds. Repayment terms can vary between one and 10 years. Personal loans can be used for almost anything, although specific lenders may place restrictions on their use. Interest rates on personal loans are fixed, so your interest rate will not change while you are paying off your loan.
Applying for a personal loan is similar to applying for a credit card. You will need to enter your personal information, your financial information and the details of your desired loan. Before approving you, the lender will perform a serious credit check, which may temporarily lower your credit score. If your financial situation and credit rating are good enough for the lender (often you need a credit rating in the mid-600s), the lender will set your interest rate, loan amount and terms. . You can open a Bankrate account to be prequalified for a personal loan in less than 2 minutes.
You will receive the personal loan funds all at once and start repaying them immediately. Your payment will be the same each month until your loan is paid off: a portion of your principal, plus interest charges.
Benefits of a personal loan
Personal loans can offer advantages over other types of loans. Here are some advantages of using this type of financing over other options.
Flexibility and versatility
Certain types of loans can only be used for a certain purpose. For example, if you take out a car loan, the only way to use the funds is to purchase a vehicle. Personal loans can be used for many purposes, from consolidating debt to paying off medical bills.
If you want to finance a large purchase but don’t want to be stuck on how you use the money, a personal loan can be a good alternative. Check with your lender for approved uses for the loan before you apply.
Lower interest rates and higher borrowing limits
Personal loans often have lower interest rates than credit cards. In September 2021, the average rate for personal loans was 10.46%, while the average rate for credit cards was 16.27%. Consumers with an excellent credit history may qualify for personal loan rates ranging from 6% to 8%. You may also be eligible for a loan amount that exceeds your credit card limit.
No warranty requirement
Unsecured personal loans do not require collateral for you to be approved. This means that you don’t have to buy back your car, house, or any other property to guarantee that you will repay the funds. If you are unable to repay the loan on the terms agreed with your lender, you will face significant financial consequences. However, you don’t have to worry about losing a house or a car as a direct result.
Easier to manage
One of the reasons some people take out personal loans is to consolidate debts, such as multiple credit card accounts. A personal loan with a single fixed rate monthly payment is easier to manage than several credit cards with different interest rates, payment dates and other variables.
Borrowers who qualify for a personal loan with a lower interest rate than their credit cards can streamline their monthly payments and save money in the process.
Disadvantages of personal loans
Personal loans may be a good option for some, but they are not the right choice in all situations. Here are some negative points to consider before taking out a personal loan.
Interest rates may be higher than alternatives
Personal loan interest rates are not always the lowest option. This is especially true for borrowers with poor credit, who might pay higher interest rates than with credit cards.
If you have enough equity in your home, you can borrow against it using a Home Equity Loan or Home Equity Line of Credit (HELOC). A home equity loan is an installment loan, while a HELOC works the same way as a credit card. One downside to having a home equity loan or HELOC is that your home is used as collateral. If you default on the loan, you risk losing your home to foreclosure.
Another alternative to personal loans is credit card balance transfer offers. You can save money with a good balance transfer offer, as long as you pay off the balance before the end of the special offer period. Our credit card balance transfer calculator will help you see how long it will take to pay off your balance.
Fees and penalties can be high
Personal loans can come with fees and penalties that can increase the cost of borrowing. Some loans have a origination fee of 1% to 6% of the loan amount. The fees, which cover the processing of the loan, can be built into the loan or subtracted from the amount paid to the borrower.
Some lenders charge prepayment penalties if you pay off the balance before the end of your loan term. Before you apply, review all the fees and penalties for any personal loan you are considering.
Payments higher than credit cards
Credit cards come with small minimum monthly payments with no deadline for paying your balance in full. Personal loans require a higher fixed monthly payment and must be repaid before the end of the loan term.
If you consolidate credit card debt into a personal loan, you will have to adjust to the higher payments and the loan repayment schedule or you risk defaulting.
May increase debt
Personal loans can be a debt consolidation tool like credit card balances, but they do not address the root cause of the debt. When you pay off your credit cards with a personal loan, it frees up your available credit limit. For people who overspend, this offers the opportunity to accumulate more burdens rather than freeing themselves from debt.
Is a personal loan right for you?
Personal loans are a great option if you need cash quickly. Here’s how to discern if a personal loan might make sense for your situation:
- You need funds quickly. With many lenders, especially those who operate online, the funds can be made available in a matter of days.
- You have a good credit rating. The lowest interest rates are reserved for borrowers who have good credit.
- You want to pay off high interest debt. Personal loans are a good way to consolidate and pay off expensive credit card debt.
- You will use the funds for necessary expenses. Other good reasons for using personal loans include paying for emergency expenses or renovating your home.
However, personal loans are not a good idea for everyone. After all, personal loans are still a form of debt. Here are some reasons why a personal loan might not be right for you:
- You have a habit of overspending. Paying off your credit cards with a personal loan may not make sense if you immediately start building up a new credit card balance.
- You can’t afford the monthly payments. Consider the repayment schedule and monthly payments for a personal loan. Use a personal loan calculator to determine whether or not you can afford the monthly payments for the term you will spend to pay it off.
- You don’t need the money urgently. It may be a good idea to build up your savings to pay for a large purchase instead of taking out a personal loan and making payments with interest for many years.
Before taking out a personal loan, plan how you will use the funds and how you will repay them (with interest). Weigh the pros and cons of taking out a personal loan rather than using another financing option. Review alternatives such as a home equity loan, HELOC, or credit card balance transfer. Use a discount rate calculator to help you determine the best borrowing option for you.
If you are considering a personal loan, get quotes from several lenders to compare interest rates and loan terms. Remember to read the fine print, including fees and penalties. Once you have all the data, decide if the advantages of a personal loan outweigh the disadvantages before you commit.