Should You Get A Personal Loan? What To Know Before You Apply
Hanna Kielar8-Minute Read
UPDATED: July 26, 2023
Whether you’re looking to combine high-interest debts or pay for a large purchase, a personal loan can be a good way to get your hands on the funds you need. While these loans offer flexible and affordable options for customers, they may not necessarily be the best option for your situation.
Let’s take a look at when a personal loan is appropriate for your finances, and when you should consider alternatives.
What You Should Know About Personal Loans
Like many other types of loans, a personal loan is a product that helps you make purchases or payments that you deem necessary. A variety of lenders – including local banks, credit unions and online lenders – offer personal loans. Whether you choose to apply online or in person, approval is based on a number of factors, including your creditworthiness.
Take a look at the personal loan process with Rocket Loans℠ to become familiar with how to get a personal loan.
How Personal Loans Work
Personal loans differ from auto loans and mortgages in that they’re typically unsecured. This means that the lender won’t require any collateral (such as your car or your house) for the debt. Personal loans are also not purchase-specific, meaning they can be used for any number of expenses.
If approved, your loan will arrive in your bank account in a lump sum. You’ll find that most lenders offer personal loans of up to $50,000, but a few may offer even more. How much money you can borrow typically depends on your personal finances.
Your credit score and debt-to-income ratio (DTI) will be the biggest factors in not only determining approval but also your loan limit. The higher your score and the lower your DTI, the more a lender is likely to offer you. Lenders will review your credit report via hard inquiry.
What You Can Use A Personal Loan For
As mentioned, you’re free to use your personal loan for more than one type of purchase or payment. Let’s take a look at a few of the most common uses for personal loans.
Debt consolidation, which often takes the form of combining multiple debts like credit cards or other high-interest debts into one, fixed-rate monthly payment on a personal loan, can help improve your credit score and decrease your credit utilization rate over time.
If you don’t have enough equity in your home, you’ll need to find another source of financing for making major renovations to your house. A personal loan can help you finance these costly home improvements, especially if you need the funds quickly.
If you’re facing any significant medical bills, you’ve recently had a large appliance kick the bucket or your car needs a major repair, a personal loan can help pay for these emergency expenses upfront and buy you a lot of time before you have to pay off the loan in full. These situations can be financially burdening, but just knowing you have options can help.
Large Purchases Or Major Life Events
When making a large purchase or planning for a major life event such as a wedding, a funeral, a dream vacation or starting a family, you may find yourself in need of financial assistance. A personal loan can help you cover the significant expenses often incurred with these events.
Deciding If You Should Get A Personal Loan
Although personal loans can be an attractive and sensible choice for many people, they don’t work best in every situation. For example, a personal loan may be ideal if you’re in an overall healthy financial situation, but it may not be if you’re struggling to make ends meet.
Below, you’ll find a few scenarios where a personal loan might be a sensible solution. Then, we’ll consider a few scenarios where you’ll likely want to pursue another option.
When Is A Personal Loan A Good Idea?
A personal loan can be a good choice if any of the following statements apply to you:
- You have a strong credit score. For borrowers with a strong credit score, a personal loan is an affordable product with a reasonable interest rate compared to a credit card or payday loan.
- You don’t want to put any collateral down. As mentioned earlier, most personal loans are unsecured. If that’s the case with your loan, your lender won’t repossess any of your assets if you default.
- You want flexibility. Some loans have limitations on how they can be used. A personal loan, however, is one of the only loan types that doesn’t have these restrictions. You can get a personal loan for any number of reasons, regardless of what you want to fund, as long as it’s not an illegal activity.
- You need cash now. With a personal loan, you can receive the funds quicker than you would with most other types of loans. With Rocket Loans’ same-day funding, you could even have your money the same day you’re approved.1
- You want a set loan term. Unlike a credit card, your personal loan will be on a fixed term, meaning you’ll know exactly how long it will take to pay off. This can make it easier to manage and budget for your monthly payments.
When Are Personal Loans A Bad Idea?
Personal loans aren’t the right option for everyone. If you meet any of the following criteria, you may want to consider looking into alternative finance options.
- You would have difficulty making monthly payments. Depending on how much you borrow, your personal loan might have a high monthly payment since there’s a set deadline upon which you must pay the loan off.
- Your credit score is low. Depending on your credit score, your interest rate may be higher than alternative options. If you have a poor credit score, it’s possibly worth pursuing an alternative option or just holding off on applying for a personal loan until you’ve improved your score.
- You don’t have your spending under control. A personal loan might not be the best idea if you don’t have your spending under control or haven’t mastered budget For instance, using a personal loan for debt consolidation or to pay down card balances becomes a bad choice if you then overspend and max out those credit cards all over again.
- If you’re planning to use it for student loan debt. If you’re using a personal loan to pay off student loan debt, you may put yourself at a tax disadvantage. That’s because the IRS allows you to deduct paid student loan interest each year when you file your income tax return. If you pay your educational debt with a personal loan, you may no longer be able to take that deduction.
- Your lender charges a prepayment penalty. Even if your original debt has a higher interest rate, a hefty prepayment penalty fee on a lower-rate debt consolidation loan could counterbalance the money you’d save. Always check before refinancing.
Alternatives To Personal Loans
In the event your situation isn’t fit for a personal loan right now, you can browse some alternative options below that might suit you better.
Home Equity Loans
A home equity loan can work much like a personal loan, only it’s secured by the equity in your home. Similarly, you can use a home equity loan for almost any type of purchase, including a home improvement or repair. However, since your home’s equity acts as collateral for the loan, this means a lender could seize your home if you fail to make your payments.
You may also consider a home equity line of credit, or HELOC, which functions much the same as a home equity loan. This revolving credit is also secured by your equity and carries the same risk of losing your home.
0% APR Credit Cards
Some credit card companies offer customers the opportunity to sign up for a new card with a 6 – 21-month promotional period featuring an annual percentage rate (APR) of 0%. You can repay your debt interest-free for this relatively brief period of time. For especially large purchases, though, you may not have enough time to fully repay your balance before the promotional period ends, so you’ll be hit with a high credit card interest rate that’s likely around the current national average of 20%.
You can also look into balance transfer credit cards.
Loans From Friends Or Family
If you have friends or family members who can spare some cash, perhaps ask if they’d be willing to lend you a one-time loan. You’ll still repay it, of course, but possibly with a more generous repayment period and a lower interest rate or none at all. Since your lender in this instance will be someone with whom you have a personal relationship, be extra vigilant about paying them back. You wouldn’t want to lose a friend over money.
FAQs: Should I Get A Personal Loan?
Here are some questions people are asking online about getting a personal loan, and when it is or isn’t the right move.
Is a personal loan right for me?
In general, a personal loan can be a good idea for consumers with excellent or good credit. Interest rates on personal loans are often very reasonable for creditworthy borrowers, making these loans relatively easy to pay back and a better option than many funding alternatives.
However, a personal loan may not be ideal for those with less-than-excellent credit. In some cases, interest rates may be too high to justify taking out a loan, and they may even rival the rates of credit cards. A personal loan may also be tricky for you if you’re self-employed.
Be sure to shop around for the best possible loan terms before moving forward with funding. You should also read the fine print of your loan to know exactly how much it’ll cost you in interest.
Should I get a personal loan to pay off debt?
As discussed, using a personal loan to consolidate debt can help those drowning in credit card debt better manage their monthly payments. However, you should also consider whether debt consolidation is a good idea for your situation. If you think you can secure a lower interest rate through consolidating, getting a personal loan might work out well for you.
What is a disadvantage of a personal loan?
Like other loan types, personal loans have pros and cons. One disadvantage of a personal loan is that a borrower with a lower credit score may struggle to qualify for a good interest rate. If that borrower then can’t repay the loan because of the high interest rate, their credit score could suffer serious damage.
Additionally, personal loans often come with additional charges like origination fees, which can be up to 8% of the loan amount.
While not for everyone, a personal loan can be a great way for some borrowers to consolidate debt or fund large purchases. These loans typically offer a lower interest rate than a credit card, on average, and have a borrowing limit up to $50,000 or even more. Depending on your situation, however, you may want to consider waiting to apply for a personal loan or choosing an alternative financing option.
If you think a personal loan is right for you, get the application process started today with Rocket Loans.
1Same day funding is available for clients completing the loan process and signing the Promissory Note by 1:00 p.m. ET on a business day. Also note, the ACH credit will be submitted to your bank the same business day. This may result in same day funding, but results may vary, and your bank may have rules that limit our ability to credit your account. We are not responsible for delays that may occur due to an incorrect routing number, an incorrect account number or errors of your financial institution.
Rocket Loans does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
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