We are an independent, advertising-supported comparison service. Our goal is to help you make smarter financial decisions by providing you with interactive tools and financial calculators, publishing original and objective content, by enabling you to conduct research and compare information for free – so that you can make financial decisions with confidence. The offers that appear on this site are from companies from which TheSimpleDollar.com receives compensation. This compensation may impact how and where products appear on this site including, for example, the order in which they appear. The Simple Dollar does not include all card/financial services companies or all card/financial services offers available in the marketplace. The Simple Dollar has partnerships with issuers including, but not limited to, American Express, Capital One, Chase & Discover. View our full advertiser disclosure to learn more.
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.
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.
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.