We all need extra cash from time to time, and sometimes we need more than a few bucks to fill the gas tank or for groceries. Sometimes you may need substantial amounts of money for things like remodeling or renovations, high-interest debt consolidation, or expensive vehicle repairs. If you use a personal loan wisely, it can help you come up with thousands of dollars to help bridge financial gaps, but what are the primary benefits of such a loan?
The major benefits of getting a personal loan are generally being able to use the loan for any needs or wants that you may have, it builds a good credit history if paid on time as it's a different credit type than cards, and they don't require any collateral.
These benefits are substantial, but personal loans are more than their benefits. There are some situations where they may be ideal, and some circumstances where you may be able to get by without using them. Personal loans can have a significant effect on your credit score and history, both when paid on time and when defaulted on, so they are not a financial tool to be taken lightly. Here's everything you need to know about personal loans.
Pros And Cons Of Personal Loans
Applying for a personal loan is a process quite similar to applying for a new revolving line of credit like a credit card, but they are considered an installment loan. They can often create an additional $1,000 to $25,000 or more for the consumer, but they will require a hard credit pull. Here are the most common pros and cons of personal loans.
Versatile & Flexible
Many loans can only be used for specific purposes, like auto loans and mortgages. This isn't the case with personal loans, which can be used for nearly anything you need, from medical bills to reducing or eliminating high-interest debt.
Better Rates & Limits
Personal loans generally come with far better interest rates than revolving lines of credit, and will also make higher amounts of money available to the borrower. The rates get better commensurate with credit, and those in the "excellent" credit bracket will frequently see interest rates in the single digits.
No Collateral Needed
Personal loans are unsecured, meaning you will not have to put up a form of collateral to secure the loan. This means that while defaulting can devastate your credit, it won't lead to the lender repossessing your car or foreclosing on your home.
Help Minimize Debt
When used to eliminate credit card debt, they are incredibly easy to manage. Instead of having several credit card payments to worry about each month, you'll have a single installment loan payment.
Rates On Alternatives Can Be Better
While personal loans often have better interest rates than credit cards, they also frequently have higher interest than other loans. For potential borrowers that have built enough equity in their home, finding a lender for a home equity line of credit or a home equity loan may be more suitable, even though they will list the home as collateral.
Some Have Significant Penalties & Fees
Origination fees for personal loans can be substantial, sometimes as high as 5%-6% of the loan amount. Additionally, some lenders set penalties for paying off your loan early. Many of the fees can simply be included in the loan amount, but if there are prepayment penalties and you pay ahead, you're going to get hit later with additional costs.
They Add To Debt
Personal loans can be used to reduce high-interest debt, but they still count as debt. This means they will change your debt-to-income ratio, if you are in a situation where you're trying to keep that optimal, like getting ready to buy a home.
Monthly Payments Can Be Considerable
Since the terms of personal loans are not open-ended like credit cards, you will often have a higher monthly payment than you realize. This is why it's incredibly important to be sure you can afford the monthly payment before agreeing to the loan.
Should I Get A Personal Loan?
There are some situations where a personal loan may be perfect, however, there are nearly as many circumstances where they are best left alone. Here are some conditions to check before you apply for a personal loan.
When Personal Loans May Be Right
- When funds are needed in a short timeframe – Many lenders can make the application and funds availability process entirely digital, getting the money in your hands in days.
- Your credit is strong – You can still get a personal loan with bad credit, though the terms and rates will be less than ideal.
- When you can use them to reduce overall debt – When used to help eliminate high-interest debt, like credit cards, they can save you hundreds or thousands in interest payments.
- If you need funds for necessary expenses – While personal loans are incredibly versatile, they are often best used for things like emergency expenses or pre-sale home remodeling, that may otherwise end up on a credit card.
When Personal Loans May Not Be The Best Option
- If you know you cannot keep to the payment schedule – knowing the affordability of the loan before you take it out is crucial, and if you can't afford it, you can make your financial situation much worse.
- If you frequently overspend or stray from your budget – If you frequently put overspending on credit cards, using a loan to reduce those balances is pointless if you're only going to increase them again.
- If the money needs aren't urgent – Everyone has a different sense of urgency, but if it's something that you may be able to save up for, you can save yourself the hassle and potential negative credit impact of a loan you don't need.
When Are Loans A Good Option To Use
For some situations, personal loans are going to be an ideal way to obtain the funds that you need for short-term applications. They are a great option if you can't get a credit card with a limit and rates equivalent to the loan, or when the personal loan may be your cheapest option for funding. They're also useful if you need a loan but have no collateral to offer against secured debt.
They are frequently used to reduce or eliminate credit card debt, pay off other high-interest debt, fund large purchases like remodeling that may otherwise use a home equity line of credit, or even used for a major life event like a wedding, once-in-a-lifetime family vacation, or milestone celebration.
Advantages Of Personal Loans
There are many potential advantages of personal loans, assuming you have the right circumstances to capitalize on those benefits and advantages. Here are some of the common advantages that attract consumers to personal loans:
- Personal loans frequently have higher borrowing limits than credit cards and even some other loan types.
- The interest rates are often far better than credit cards, making them a more affordable way to bridge financial gaps.
- Personal loans will not usually require any collateral before being approved, so default means you keep your property.
- A single personal loan is often much easier to manage than taking high-interest loans from several different credit cards that may have various rates, fees, and repayment terms.
- The repayment terms of personal loans are generally predictable and relatively consistent.
- To make payments more affordable, personal loans can have terms that extend much longer than payday loans, for example.
- Personal loans can help your credit history when paid on time each month.
- Most lenders have a fully digital application process, making them extremely easy to obtain.
- The interest rates are fixed, so you won't have any surprises when it comes to the life of your personal loan.
- Personal loans can be used for just about anything you want.
Is Taking Out A Personal Loan Bad?
Taking out a personal loan isn't bad, quite the opposite, they can be incredibly useful financial tools when used properly. One of the biggest factors will of course be whether you can afford the loan payments and interest over time. Another factor that should weigh heavily on your considerations is your overall credit health, since the terms and rates of your personal loan will depend on your creditworthiness, damaged credit may cost you considerable interest.
Since you are borrowing funds from someone, you will be paying interest, and your interest rate can be significantly higher than a credit card if your credit isn't in good shape. The average personal loan will see rates anywhere between 5% and 35%, so if you do need a personal loan and have damaged credit, it may be well worth the time and effort to shop around for the best rates and lenders.
Being Fully Informed About The Uses & Benefits Of Personal Loans Is Critical
There's a lot to consider when thinking about applying for and taking out a personal loan. Knowing what you're getting into is crucial for making the right decision for your credit and finances. There are many benefits they offer, and plenty of drawbacks as well if used irresponsibly. Being informed can help you decide if a personal loan is what you need for your next large expense.
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Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.