You may have seen numerous lenders on Google providing various rates and offers labeled "personal loans." It can be confusing. Fundamentally, a personal loan is an installment debt that allows the borrower to use the funds for any personal purpose or debt consolidation.
In this article, we'll explore the benefits and drawbacks of getting a personal loan and help you decide if it's the right financial decision for your situation. Let's find out.
What Is a Personal Loan?
A personal loan allows you to borrow money from banks, credit unions, or online lenders to pay for personal expenses and repay those funds over time. Unlike other loans, such as mortgages or auto loans, personal loans don't require you to specify how to use the funds.
Personal loans are installment loans that allow you to receive one-time funding if approved by the lender, and repay a fixed amount each month over a specified period. The length of the loan term can vary, but most personal loans offer terms of two to seven years.
To qualify for a personal loan, you'll need to meet the lender's specific requirements. The lender will typically check your credit score and income to determine your ability to afford the loan. Applicants with good credit scores and stable incomes are more likely to be approved for a personal loan.
Pros of Personal Loans
Personal loans offer several advantages over other forms of credit. Here are some of the key benefits of personal loans:
1.One lump sum
One of the advantages of a personal loan is that you receive the loan amount as a lump sum payment upon approval. This can benefit moving expenses, house flipping, medical bills, wedding costs, debt consolidation, and other unforeseen expenses.
2.Fast funding times
Personal loans generally have fast approval and payment times, making them useful for emergencies or other situations where you need money quickly.
Many lenders issue a one-time payment through ACH or direct deposit into your bank account, allowing you to expect the payout by the same day or the next business day.
3.No collateral requirement
Unsecured personal loans dont require collateral for you to get approved. This means you dont have to put your car, home, or another asset up as a guarantee that youll repay the funds.
Most personal loans are unsecured. This means that should you default on the loan by chance, you won't risk losing your house, car, or other types of collateral upon the contract. With an unsecured loan, a lender cant take your collateral for failing to repay the loan, at least without a courts permission.
4.Lower interest rates
Personal loans often come with lower interest rates than credit cards. Good credit history can qualify for personal loan rates of around 7.49 percent to 12.5 percent or even lower. You can save money on interest if you have good credit and take out a personal loan instead of a credit card.
However, you may also qualify for a higher loan amount than the limit on your credit cards.
5.Flexibility and versatility
Personal loans can be used for many purposes, from consolidating debt to paying medical bills. A personal loan can be a good alternative if you want to finance a major purchase but dont want to be locked into how you use the money.
6.Extended Loan Terms
Personal loans typically offer longer loan terms, usually 12 to 60 months, compared to other short-term loans like payday or title loans, which charge high-interest rates. Consequently, youll get a reasonable monthly payment and ample time to repay what you borrow.
This will significantly benefit the borrower to access more affordable capital and reduce pressure on the monthly repayment amount. However, there is no perfect solution in the real world. With longer repayment terms, the total interest cost may be higher than a short-term loan with the same rate.
7.Provide Flexible Borrowing Limits
Personal loans are typically available between $1,000 and $100,000, making them a good option for borrowers needing a specific amount. Borrowing limits vary by lender, and getting a larger loan amount may be more challenging than qualifying for a smaller amount.
8.Easier to manage
A personal loan with a single, fixed-rate monthly payment is easier to manage than several credit cards with different interest rates, payment due dates, and other variables.
Since credit cards have a 24.15% APR on average, borrowers who qualify for a personal loan with a lower interest rate than this number can reduce their monthly payments and save a remarkable amount.
Cons of Personal Loans
While personal loans come with many advantages, there are also some drawbacks to consider before applying for one.
1.Interest rates are high for applicants with poor credit.
One of the most significant disadvantages of personal loans is that their interest rates can be higher than other options, especially for those with poor credit. If you have a lower credit score, you might pay more interest than you would for a credit card or a secured loan.
2.Must meet the eligibility criteria.
Personal loans may also have more stringent eligibility requirements than other financing options. For instance, fewer lenders may be available to you if you have a short financial history or a poor credit score. Additionally, some lenders may not allow you to co-sign with your parents or individuals with better financial situations, making it more difficult to obtain approval if you have a limited credit history.
3.Do not ignore the fees and penalties.
Personal loans may come with fees and penalties that can increase the cost of borrowing. For example, some loans come with origination fees ranging from 1% to 6% of the loan amount.
Sometimes, lenders may charge prepayment penalties if you pay off the loan earlier than what is specified in the agreement or contract. Reviewing all fees and penalties before applying for any personal loans is essential.
4.Extra recurring monthly expenses
Another potential disadvantage of personal loans is that you'll add another monthly payment to your budget. If you don't carefully manage your monthly budget, this could lead to defaulting and damage your credit score once your expense excessed your income. In such cases, making the monthly payment may cause you to overdraw your account and put your budget in the red.
5.Increase your total debt amount.
While personal loans can be a valuable tool for consolidating debt, they need to address the root cause of the problem. A personal loan can be used to consolidate your credit card debt, but it may also create the illusion that you have more purchasing power now. This is not true, as the debt will only be eliminated if you actively work to reduce the amount.
6.Fixed Amount v.s Minimum Payment.
Personal loans require higher fixed monthly payments because they are an installment loans in principle. In contrast, credit cards come with small minimum monthly payments and no deadline for paying off your balance in full. Therefore, if you consolidate credit card debt into a personal loan, you must adjust to the higher payments and loan payoff timeline or risk defaulting.
7.Negative impacts on credit score
Personal loans can positively impact your credit score if you keep up with your monthly payments or fail multiple loan applications. When you apply for a loan, the lender will conduct a hard credit inquiry, knocking your score down a few points. Moreover, a high debt-to-income (DTI) ratio and high utilization rate can significantly affect your credit score from increasing or even cause it to decrease. The likelihood of getting approval for a new loan or credit card may be low.
8.Avoid unnecessary debt
Cutting unnecessary expenses is generally more effective than obtaining a loan to maintain the same lifestyle. Before committing to a loan, evaluating why you need the funds and whether a personal loan is the best solution for your situation is essential.
When Is a Personal Loan a Good Idea?
A personal loan may be viable if it offers lower costs than other credit types and the monthly payments can be comfortably managed for the entire loan term. Some everyday situations where people may consider taking out a personal loan are listed below.
1.Quick Access to Funds
A personal loan may be a good option if you need money urgently. It is relatively quick to apply for, and once approved, the funds can be disbursed quickly.
2.Consolidating High-Interest Debt
If you have high-interest debt, such as credit card debt, consolidating it with a personal loan can be brilliant. Personal loans often have lower interest rates than credit cards, saving you money in the long run. You can also simplify your debt repayment by having one monthly payment instead of several.
3.Paying Off Other High-Interest Debts
While personal loans may have higher interest rates than other loans, such as mortgages or car loans, they can still be a better option than high-interest loans like payday loans. Consolidating these loans into a personal loan can help you save money on interest and reduce your debt.
Even with an excellent interest rate, you should pay attention to the potential repayment penalty for the old loan and the origination fees or processing fees associated with the new loan. These costs may be significantly higher than what you anticipated.
4.When you need to make Home improvements:
Home improvement or house flipping can be excellent uses for a personal loan, as they often function more like investments that add value to your property. However, a downside is that property taxes may increase due to the rise in home value. Unlike a home equity loan, you don't have to use your house as collateral, making it a less risky option.
5.To Build Credit History
Payment history is a critical factor in many credit score models, accounting for up to 35% of your FICO credit score.
Taking out a personal loan and making every single payment on time can be a helpful way to improve your credit score, particularly if you have a limited credit history or a poor record of on-time payments in your credit report. However, avoiding missing any payments is essential, as this could damage your credit score.
6.When you need to Pay for Purchases Over Time
Personal loans can be used to make large purchases and pay them off over time. This can be a good strategy for necessary purchases, such as a new car or medical expenses. However, you should never rely on something other than a personal loan for unnecessary leisure spending, as it will not help you achieve the debt-free goal.
When Do Personal Loans Not Make Sense?
1.Undefined Purpose for Funds:
Taking out a personal loan without a plan for how the funds will be used may result in spending money on non-essential items and paying unnecessary interest.
Remember, you should aim to transform your debt into an asset or investment because you are paying lenders additional money for any borrowing, including personal loans. Your borrowing cost is considered profit for the lenders.
With that in mind, it would be a terrible choice to use the loan for a luxurious two-door car or a dream vacation instead of paying off high-interest debt. To avoid paying unnecessary interest charges, saving money in advance for such big-ticket items is advisable.
Personal loans can be costly, even for borrowers with poor credit. Consider alternative options like rainy-day funds or payday loan alternatives for emergency expenses.
3.Inability to Afford Monthly Payments:
When considering a personal loan, it's essential to evaluate the repayment timeline and monthly payments using a personal loan calculator to ensure affordability.
Medical bills can often be paid through lower-cost payment plans, and usually, the payment options are negotiable, making personal loans less favorable. Only consider personal loans if other payment options are unavailable.
A personal loan is not a one-stop solution for individuals who are overspending. It often has the opposite effect, leading people into a debt trap. As mentioned, reducing unnecessary expenses and creating a sensible spending plan can significantly improve your financial situation.
Things to Consider Before Applying for a Personal Loan
Do your research and compare lenders.
Before taking out a personal loan, make sure to do your research and compare lenders. Look for reputable lenders with good customer reviews and reasonable interest rates.
Reconsider Taking Out a Personal Loan for Nonessential Expenses
As we discussed before, using personal loans for unnecessary items like luxury items is not suggested. Consider saving up for these items instead of taking on debt.
Watch Out for Scams
Be wary of lenders that offer guaranteed loans or ask for upfront fees. These could be signs of a scam.
Read the fine print and ask questions before signing any loan agreements.
If a lender commits to providing an offer that is unrealistically way better than any other in the market from all perspectives, exercise caution when dealing with this lender, as they might attempt to scam you for a deposit or your personal information. Researching the lender's background through the Better Business Bureau or the Consumer Financial Protection Bureau is best.
Don’t use personal loans to consolidate student loans.
Although personal loans can consolidate many types of debt, they're generally not a good idea for student loans, which tend to have lower interest rates.
Make a Plan to Pay Back the Debt Before You Apply
Before applying for a personal loan, make sure you plan to repay the debt.
Having a good understanding of your monthly repayment capacity is a priority before applying for a personal loan. Typically, the amount should be your monthly income minus any recurring monthly payments.
How to Get a Personal Loan?
Determine your credit score:
Before applying for a personalloan, check your credit score to see if you'll qualify. You can check your credit score for free with various online services.
(You can access your full credit report, including all payment history and details from The three major credit bureaus: Equifax, Experian, and TransUnion.)
Evaluate the total loan amount and interest rate:
Use a personal loan calculator to estimate how much you'll pay in interest and monthly payments based on your credit score and the loan amount.
Look for lenders that offer personal loans with terms that suit your needs. Consider interest rates, fees, repayment terms, and eligibility requirements.
Gather your documentation:
Most lenders will require you to provide proof of income, such as pay stubs or tax returns, and identification documents, such as a driver's license or passport.
Apply for the loan:
Fill out an application with the lender you've chosen.
The application may include but is not limited to personal information, income and employment, assets, liabilities and indebtedness, loan purpose, joint applicant information, and so on.
Review and Accept loan offers:
Once you've submitted your application, lenders may provide loan offers for you to review. Carefully consider each offer's interest rates, fees, and repayment terms before choosing one.
After selecting a loan offer, carefully review and sign the loan agreement. You should carefully review the terms and conditions. If you have any concerns or ambiguities in the contract, please ask your lender for clarification before signing.
Receive and use the funds:
Once you've signed the loan agreement, the lender will typically deposit the funds into your bank account within a few days.
How to Find the Best Personal Loan for You?
Considering the following factors before making the final decision is essential, as they will significantly impact your benefits and potentially increase your borrowing costs.
Look for lenders with competitive interest rates. A lower interest rate means you'll pay less in interest over the life of the loan.
Check for origination fees, prepayment penalties, and other fees that could add to the cost of your loan.
Determine how much money you need and ensure the lender offers loans in that range.
Consider the length of the loan term and monthly payments to ensure you can afford to make payments on time.
Credit score requirements:
Check the lender's credit score requirements to ensure your loan eligibility.
Some lenders specialize in specific types of loans, such as debt consolidation or home improvement loans. Choose a lender that specializes in the kind of loan you need.
Check thelender's reputation through online reviews and ratings from previous borrowers.
Are there any Alternatives to Personal Loans?
Yes. Several alternatives to personal loans may be more suitable depending on your financial situation and needs. Here are a few options to consider:
Home equity loan:
If you own a home with equity built up, you can take out a home equity loan. This type of loan uses your home as collateral and typically comes with lower interest rates than personal loans.
It works similarly to a personal loan, with fixed installments and interest rates. However, in home equity loans, your home serves as collateral for the loan. Defaulting on the loan could result in losing your home, which would be significantly more catastrophic than surrendering a car in an auto loan or experiencing a decrease in credit score for a personal loan.
Home equity line of credit (HELOC):
HELOC is similar to a home equity loan but works differently, much more like a credit card, allowing you to access the funds as you choose. Most lenders usually feature variable interest rates, while some provide fixed rates for a certain period. This can be a good option if you have ongoing expenses, such as home renovations, that will be spread out over time. Similar to a home equity loan, a lender can foreclose on your home if you fail to repay the loan.
0% APR credit card:
You can qualify for a credit card with a 0% APR introductory offer if you have good credit. This can be a good option for financing purchases or consolidating debt without paying interest for a set time. However, pay off the balance before the introductory period ends, as the interest rate will increase significantly afterward.
FAQs About Should You Get a Personal Loan
1.What Can I Use a Personal Loan For?
Yes. A personal loan can be used for various purposes, including buying a big-ticket item, covering home improvement expenses, or consolidating high-interest debt.
However, some lenders may have specific restrictions on how you can use these funds, as clarified in the contract. Evaluating your financial situation and goals before taking out a loan is wise since you will carry the interest cost on a personal loan.
2.What Do I Need to Take Out a Personal Loan?
The requirements to obtain a personal loan vary depending on the lender, but there are unsecured unique loan options that don't require any collateral. It's important to check with the lender to see their specific requirements before applying for a loan.
3.Do personal loans come with fees?
Personal loans may come with fees, such as an origination fee and a one-time charge deducted from the loan amount to cover processing and administrative costs. This fee typically ranges from 1% to 5% of the loan amount, but some lenders may charge a flat-rate fee.
Some banks, such as Wells Fargo, offer options with no origination fees, closing fees, or prepayment penalties, but this may only be the case for some lenders. It is recommended to carefully go over all details with lenders to determine if there are any additional costs other than the interest cost.
4.Do I have a good enough credit score?
To determine whether you have a good enough credit score to qualify for a personal loan, you can check your credit score through several free online credit scores services, such as Credit Karma or Credit Sesame.
Most personal lenders have a fast processing time and a higher approval rate for applicants with good credit scores. If that doesn't apply to your situation, you may consider credit unions that provide more flexible borrowing programs with relatively low-interest rates.
Remember that if your credit score is low, you may be required to pay higher fees and interest rates.
5.How will a personal loan affect my credit score?
Initially, it may cause a slight drop in your credit score because it results in a new inquiry on your credit report. However, consistently making on-time payments towards your loan shows that you are responsible and reliable with credit, which will improve your credit.
Additionally, taking out a personal loan can help diversify your credit mix and benefit your credit score. Personal loans are a form of installment credit, whereas credit cards are considered revolving credit. Having both types of credit in your profile will strengthen your credit mix.
On the other hand, missing payments or defaulting on a personal loan will hurt your credit score and can lead to collection efforts and legal action.
6.How long will I have to pay it back?
Personal loan repayment terms can vary depending on the lender and the loan amount. Generally, lenders provide a repayment period of six months to seven years. Borrowers must start paying the loan back in monthly installments within 30 days of the loan being disbursed. Choosing a repayment term that fits your budget and financial goals is essential, as both your interest rate and the monthly payment will be affected by the length of the loan.
7.What interest rate should I expect to get?
Interest rates can range from as low as 5.99% to as high as 29.99% or more.
You have such a wide range of interests because various factors impact the figure, as we mentioned, such as the loan amount, repayment terms, credit score, collateral, employment status, income, etc.
Having a good or excellent credit score and selecting a shorter repayment term qualify you for the lowest interest rates. The APRs for personal loans are usually fixed so the rate won’t change throughout the loan cycle. However, some lenders offer a fixed rate for the first few years and then turn it into a variable rate.
In conclusion, a personal loan is just one financial tool. Depending on its use, its impact on the borrower can be beneficial or harmful. This fund can be used to consolidate high-interest debt to reduce the capital costs of your debt.
On the contrary, it can be used to purchase a luxury watch and drag you deeper into the debt trap. A feasible spending plan, along with a reasonable repayment schedule, should be placed in higher priority instead of getting loan approval. After reading this article, you have a solid understanding of a personal loan.
With careful consideration and planning, a personal loan can be a helpful tool in achieving your financial goals. So, should you get a personal loan? The answer depends on your circumstances and needs.
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