Personal loans are a simple, flexible way to cover major expenses, home improvements, or even weddings. But is getting a personal loan a good idea?
Advantages of Personal Loans
Curious about the pros and cons of personal loans? Here are a few of the best reasons to take out a personal loan.
- Flexible Funding – Personal loans are easily one of the most versatile loan programs out there. A personal loan can be a great option if you need funding without being locked into how you use the money.
For instance, you might use a personal loan to cover home remodeling or repair, then use the excess to pay down your credit card debt.
- Lower Interest Rate than Credit Cards – According to the Federal Reserve, the average interest rate for a personal loan is 8.73%, with some online lenders offering rates as low as 5.99%. Depending on your credit card provider, this can be a more affordable option, as it lowers the total repayment amount of the loan.
- No Collateral Needed – Since most personal loans are unsecured, you won’t have to put up your car, home, or other assets as collateral. This means that even in the worst-case scenario, you won’t have to worry about losing your property if you’re unable to repay the loan.
- A Single Lump Sum – Need cash immediately? A personal loan comes in a single, lump sum payment, making it easier to pay down your credit card debt, settle your medical bills, or get started on that home remodeling project.
Receiving a lump sum also means you’ll have a better understanding of how much you’ve borrowed, making it easier to adapt the repayment schedule to your budget.
- Rapid Approval – In an emergency, you don’t have time to wait for the bank’s approval to get the funding you need. Thankfully, personal loans offer quick turnaround and fast payment, so you’ll have access to the funds you need quickly. That’s good news if you need to cover a car repair, medical bill, or other urgent expenses.
Disadvantages of Personal Loans
As useful as personal loans can be, there are some situations where it might be better to avoid them. Here are a few of the potential downsides of personal loans.
- High Eligibility Requirements – Depending on your lender, you could face high eligibility requirements to obtain a personal loan. According to TransUnion, the most favorable interest rates go to borrowers with a credit score of 720 or higher, with rates spiking for those with scores below 600.
- Higher Interest Rates than Secured Loans – While personal loans offer better interest rates than consumer credit cards, the rates can potentially be better if you use another type of loan, particularly a secured loan.
- Higher Minimum Monthly Payment than Credit Cards – Credit card providers typically have a lower minimum monthly payment required than a personal loan. Consequently, repaying your loan will take a larger bite out of your budget than repaying your credit card debt.
Making minimum payments on a credit card on a regular basis is a terrible idea that can quickly get you deep into a debt trap, but having the option of making a minimum payment in a rough month gives you added flexibility.
- High Fees and Penalties – Many lenders charge origination fees of 1-6% (or higher, for some online lenders) that only add to the cost of the loan. And if you miss a payment, you could likewise be facing a steep late fee that adds insult to injury.
Depending on your lender, you might also face an early payment penalty, which means you can’t make additional payments to get out from under the loan without taking another financial hit.
- Shifts Your Debt-to-Income Ratio – Any loan will add to your overall debt. This can come back to haunt you since lenders will use your debt-to-income ratio to determine your eligibility for home loans or other lending programs.
Since personal loans are comparatively small (averaging just over $8,000), some borrowers may want to consider building their short-term savings to cover emergencies or projects.
What Is a Good Reason to Get a Personal Loan?
According to a recent report, over half of all Americans (56%, to be exact) don’t have enough savings to cover a $1,000 emergency expense. What do you do if the unexpected should happen?
This may be the single best reason to take out a personal loan. The sum you receive can serve as fast, flexible funding to cover the cost of a major car repair or medical bill or quickly get you out of debt. What’s more, personal loans typically offer significantly better rates and terms than payday loans.
Remember, however, that personal loans are among the most flexible loan programs available to consumers. If you’re planning on taking out a loan to cover a home remodel, it might be worth comparing the rates of personal loans against home equity loans.
The single most common reason for taking out a personal loan is debt consolidation. Many people take out a personal loan to pay off and consolidate higher-interest credit card debt. This can be effective if your credit is good enough to get a low-interest loan, but be sure you understand the debt consolidation process and that you don’t take on new debt until the old debt is paid off.
Depending on your needs, you might discover that a personal loan offers better rates and terms than other loan programs, though you should always make it a point to compare multiple lenders and loan programs before you commit.
Is Getting a Personal Loan a Good Idea?
Are personal loans worth it? It depends. A personal loan may be one of your best options if you need emergency cash now. That said, your loan’s value will depend on your particular financial situation.
Personal loans make the most sense for those with good credit — if you have a solid credit history, you’ll qualify for the most favorable loan terms and obtain a sizable personal loan to cover your expenses. This makes them a decent option for consolidating your debt or paying off your bills quickly.
On the other hand, a personal loan isn’t always the best option. Home remodeling jobs are often better covered through a home equity loan, which will offer low interest rates and flexible financing options. Similarly, the interest rates and origination fees only add to the cost of personal loans. It may be smarter to try to build up your emergency savings. That way, you’ll have an interest-free cushion in case the unexpected happens.
Look Before You Leap
For some, a personal loan may be the best and most direct option, especially when you need cash immediately. Others might want to consider alternative loan programs to cover specific needs or take the time to build up an emergency savings fund to cover unexpected costs.
If you choose to pursue a personal loan, always shop around. Even when you’re under a time crunch, you can usually compare lender rates online. Make an effort to fully understand the rates, terms, origination fees, and other conditions before committing.
A personal loan can be a boon under the right circumstances. Just make sure you understand what you’re getting.