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. Personal loan balances have nearly doubled in the past four years. In 2015, loan balances were about $72 billion. In the first quarter of 2019, loan balances climbed to more than $143 billion

Whether you’re considering using a personal loan to pay off credit card debt, catch up on medical bills or finance an unexpected purchase, taking a look at the pros and cons of personal loans is a must.

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    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.

    Get Started

    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.

    [Find out if a personal loan is your best option.]  

    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 many other uses. The flexibility of the loan is what makes it one of the most popular borrowing tools on the market.

    Quick approval

    With the growing number of online lenders, you can often apply (or pre-qualify) for a personal loan online and receive an answer the very next day. It’s possible you can visit your local bank or credit union and get the same treatment, especially if you have an established relationship with the bank. 

    Length of term

    Repayment terms vary from one lender to the next, but many personal loans have terms that can range from 12 months to seven years. Of course, exact terms depend on your credit score, credit history, and the amount you borrow. 

    Interest rates can be lower than credit cards’

    If you have good credit, you can generally get a much better interest rate on a personal loan than you might on many credit cards. The Federal Reserve reports that the average interest rate on credit cards in the U.S. has been around 14% to 15% APR since early 2018. Compare that to the national average of 9.41% for personal loans, as reported by Experian. Even a difference of between 5% or 6% can make a lot of difference over the term of the loan. 

    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 could still be ruined from default, you get to keep your assets.

    [Read: Best Personal Loans for Bad Credit

    Disadvantages of personal loans

    Some have higher interest rates

    Because most personal loans are unsecured, the lender is taking on higher risk. 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 good overall credit, the cost of a personal loan could be even higher.

    [Learn how to get a personal loan with fair credit]

    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 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.

    Possible fees and charges

    One downside to many personal loans are the fees that lenders charge. Some lenders charge a loan origination fee or loan processing fee, or they tack on a prepayment penalty if you pay off your loan before the end of the term. Fees and penalties can really add up, so be sure to check with your lender beforehand to see if fees are negotiable. 

    Fixed rates

    Fixed monthly payments are great for budgeting, but they can be a bother if you’re accustomed to smaller monthly payments and long pay off periods like with credit cards. Keep in mind too that if you’re late with a payment or default on your loan, your credit will suffer. 

    Your credit rating matters

    Yes, you can get a personal loan with poor credit, but your interest rate will be high. If you have good credit, your interest rate may be much lower. For instance, if you borrow $10,000 at an interest rate of 10% and a term of five years, your monthly payment will be $212.47, and you’ll pay $2,748.23 in interest over the term of the loan (not counting fees). However, if you took out a loan of $10,000 at an interest rate of 4.5% and a term of five years, your monthly payment would be $186.43, and you’ll pay a total of $1,185.81 in interest (not counting fees). 

    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

    Alternatives to personal loans

    Personal loans are a good option for a variety of reasons. But there are alternatives to consider, depending on your needs.

    Home equity loan or personal line of credit. If you have equity in your home, you may be able to borrow against it with a home equity loan. But beware, if you default on your payments, you might lose your home. A home equity line of credit is somewhat like a credit card, where you only borrow as much as you need and pay it back in monthly installments.

    A 0% credit card. A 0% interest rate on credit cards can be a great alternative to a personal loan. You can borrow up to your credit limit and pay no interest. But you must pay off the balance before the promotional period ends or you’ll end up paying interest on the balance.

    Peer-to-peer loans. Unlike visiting your bank or credit union for a loan, you can go online to lending marketplaces and borrow money from investors. P2P lending marketplaces can benefit borrowers who have less-than-stellar credit and may not qualify for loans at traditional financial institutions.

    Salary advance. Some employers will “lend” you money prior to you actually earning it. If it’s an emergency and you need funds fast, you may consider checking with your employer to see if this is an option. 

    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.

    Get Started

    Getting a personal loan with bad credit

    It may be challenging to get a personal loan with bad credit, but it’s not impossible. You may end up paying a high interest rate, but it will likely be much lower than with payday loans. You also may be limited to how much you can borrow and have a shorter (or longer) term than if you have good credit.

    Anything under 580 is considered a bad FICO score. Anything under 600 is considered a bad Vantage score. But your credit score isn’t the only thing lenders look at. They also may review your debt-to-income (DTI) ratio, credit history, and whether you have a stable job and income. If you have an established relationship with your bank or credit union but have fallen on tough times, they may look at your payment history and give you a break. It’s worth a try.

    Check Your Personal Loan Rates

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

    Get Started

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    Personal loans FAQ

    A personal loan, also called a consumer loan, is an installment loan. You pay back the amount you borrow – plus interest – over a set period of time. Some personal loans require collateral, but most don’t. You can use a personal loan for many things, like debt consolidation, unexpected emergencies, large purchases and home improvements.

    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.

    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.

    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.

    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.

    Kathryn Pomroy

    Contributing Writer

    Kathryn Pomroy is a journalist and freelance writer. She has written for dozens of major publications, small businesses and many well-known companies. As a writer, she turns the details of an assignment into something that is compelling, digestible and useful. Kathryn holds a BA in Journalism and drinks black, super bold coffee while eating peanut butter and honey toast. Yum.