Pros and Cons of Taking Out a Personal Loan

Personal loans can be a great source of quick cash when you need to pay for something unexpected. But is it the right type of funding for you? Understanding the pros and cons of personal loans is the best way to answer that question. As of 2018, personal loans accounted for $138 billion in outstanding debt.  Whether you’re considering using a personal loan to pay off credit card debt, catch up on medical bills or finance an unexpected purchase, a good review of the option is a must.

Check Your Personal Loan Rates

Answer a few questions to see which personal loans you pre-qualify for. The process is quick and easy, and it will not impact your credit score.

Advantages of personal loans

They help with debt consolidation

Debt can get confusing when you have multiple lenders to pay every month. Additionally, you may have some loans that are considerably more expensive than others. One of the biggest personal loan advantages is to use it to pay off credit card debt or consolidate other accounts by wrapping all of your outstanding debt into one loan. This means one payment every month, and it can also mean savings or lower payments — depending on your goal.

You can meet a wide array of different financial needs

Debt consolidation is only one of the many ways that a personal loan can be used. Personal loans can also be used for emergency expenses, purchasing appliances, making needed repairs, medical bills, covering a deductible or any one of many other uses. The flexibility of the loan is what makes it one of the most popular borrowing tools on the market.

Collateral is not required

Most personal loans come without the need for collateral. This is quite different from an auto loan, where if you default, you lose your car. While your credit would still be ruined from a default, you still get to keep your assets.

[Read: Best Personal Loans for Bad Credit in 2020

Disadvantages of personal loans

Some have higher interest rates

Because most personal loans are unsecured, the risk will be higher to the lender. The cost of lending is directly correlated to the risk to the lender. As personal loans fall under this umbrella, your interest rate may be higher, and therefore, your overall cost may be higher. There are more affordable forms of borrowing, but those methods may not meet the unique financial needs you’re looking to cover. And if you don’t have overall good credit, the cost of lending with a personal loan could be even higher.

They can affect your credit score

Any time you add debt to your financial profile, it’s going to affect your credit score. Personal loans increase the amount of debt you have, lower the age of your credit accounts, initiate a hard inquiry during the approval process and register as a newly opened debt account. All of these things will have either a short-term or long-term negative effect on your credit score.

While there’s no real way to avoid this and it’s just one of the intangible costs of borrowing, it could be a big issue if you have another upcoming financial move on the horizon. For example, if you are looking to buy a house or a new car soon, taking out a personal loan may lower your chances of approval for that loan or raise the rate you get charged on the purchase. In these situations, this could be a significant personal loan disadvantage.

If you don’t have an upcoming major financial move, the long-term effect of making good on your personal loan payments is a net positive.

When is a personal loan a good idea?

Under the right circumstances, a personal loan can be the right idea to meet your financial needs. The first thing to look at is what you are borrowing the money for. Personal loans should never be used for luxury or non-essential purchases. For example, a personal loan to buy a new watch or a gift is a bad idea, but a personal loan to cover unexpected medical loans is a better idea.

The second thing to look at is your current financial situation and your ability to repay the loan. No matter how dire your situation, you should never take out a personal loan if you don’t have a solid plan for repayment. But if you choose to take out a loan, think about your payment timeline, your payment amounts and how that relates to your expected income throughout the loan.

Make sure you are never borrowing money for a personal loan based on an emotional decision. Only after you look at your needs, financial situation and repayment plan should you consider moving forward with securing a loan.

[Read: You Can Improve This Part of Your Credit Score Almost Immediately

Check Your Personal Loan Rates

Answer a few questions to see which personal loans you pre-qualify for. The process is quick and easy, and it will not impact your credit score.

Personal loans FAQ

Does it cost anything to apply for a loan?

Generally, there are no costs associated with applying for a personal loan. While this should be the case for nearly all lenders, it’s still important to double-check before completing your application. For example, payday alternative loans (a form of personal loan) generally carry up to a $20 application fee.

How soon can I get my money after my loan is approved?

The speed in which you get your money after your personal loan is approved depends on the lender you’ve selected. The best personal loan companies can get you funding within as quickly as a few hours or the next business day. You’ll also want to check with your bank or credit union to see if there will be any delay in getting access to the funds.

I already have a loan. Can I get another?

Yes. With many lenders, you can get a second personal loan if you already have one out. However, keep in mind that having a personal loan out may affect your credit score. If you already have a loan out, you may have a harder time getting approved for a second loan unless you have fair credit or good credit.

What happens if I can’t repay the loan?

If you’re unable to repay your loan, the first thing you should do is reach out to your lender for help. If that does not help, your loan will start to register late payments and then go into default. The result will be extensive damage to your credit. Additionally, some lenders may choose to file a lawsuit against you to try and recover the funds that you owe them.

Too long, didn’t read

The pros and cons of personal loans can help determine whether the borrowing medium is a good fit for your financial needs or not. For many, the list of personal loan advantages will outweigh the negatives and drawbacks.

Keep reading

How to Get a Personal Loan With Fair Credit 

How to Pay Off Your Student Loans Fast 

Personal Loan vs. Credit Card: Which Is Better?

We welcome your feedback on this article. Contact us at inquiries@thesimpledollar.comwith comments or questions.

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Jason Lee
Jason Lee
Contributing Writer

Jason Lee is a U.S.-based freelance writer with a passion for writing about dating, banking, tech, personal growth, food and personal finance. As a business owner, relationship strategist, and officer in the U.S. military, Jason enjoys sharing his unique knowledge base and skill sets with the rest of the world. Follow Jason on Facebook here

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  • Andrea Perez
    Andrea Perez
    Personal Finance Editor

    Andrea Perez is an editor at The Simple Dollar specializing in personal finance. Prior to that she specialized in digital marketing content for online learning websites. She holds a master’s degree in journalism and media studies from the University of South Florida.