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When are Personal Loans a Good Idea?

6-Minute Read

Whether you’re looking to combine high-interest debts or pay for a large purchase, a personal loan is one way to get your hands on the funds you need right now. Personal loans are typically a better (and cheaper) option than turning to credit cards, and often come with a timely repayment plan and no requirements for collateral, making them ideal for many borrowers.

While these loans offer flexible and affordable options for customers, are they really the best funding option available? Let’s take a look at the impacts of personal loans on your finances and credit, and how to decide if taking out one of these loans is the right choice when you need extra cash.

What is a Personal Loan?

Like many other loan types – such as mortgages or auto loans – a personal loan is a product that helps you finance the things you want (or need) to buy. Personal loans are personal and offered by a variety of lenders, such as your local bank or credit union or an online lender. Approval is based on a number of things, including your creditworthiness.

However, unlike most other loan types, a personal loan isn’t purchase-specific. While auto loans are only given for vehicle purchases, student loans are only offered for educational expenses, and mortgages are only for those buying a home, personal loans can be used for any number of things.

 

Also unlike auto loans and mortgages, personal loans are unsecured. This means that the bank won’t require any collateral (such as your car or your house) for the debt.

Personal Loan Uses

So, what can you do with a personal loan? The answer is pretty much anything!

As mentioned, your lender may want to know what you plan to do with the money before it approves your loan, but you can use a personal loan for so many things. Whether you want to take your family on vacation, remodel your home, pay for expensive medical or dental treatment, consolidate existing high-interest debt or pay for a wedding, a personal loan is likely your best option.

You could even choose to take out a loan for emergency expenses – such as a new A/C unit when yours kicks the bucket. If your emergency fund isn’t enough to cover these sudden purchases, a personal loan is often a better choice than using your high-interest credit cards .

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The Benefits of Obtaining a Personal Loan

If you’re considering a personal loan, you may already realize many of the selling points.

Some of the most helpful personal loan benefits include:

  • Interest rates: Compared to credit cards or payday loans, personal loans are much more affordable products with reasonable interest rates.
  • No collateral: Most personal loans are unsecured, meaning that you won’t need to put up any collateral for your funds.
  • Flexibility: You can get a personal loan for any number of reasons, regardless of what you want to fund.
  • Knowing your end date: Unlike credit cards, your personal loan will be on a fixed term, meaning you’ll know exactly how long it will take to pay off.

Are Personal Loans a Good Idea?

In general, personal loans can be a good idea for consumers with excellent credit. Interest rates are often very reasonable for creditworthy borrowers, making them relatively affordable to pay back and a better option than many funding alternatives.

Personal loans may not be ideal for those consumers with less-than-excellent credit, however. In some cases, interest rates may be too high to warrant taking out a loan, even rivaling the rates of credit cards in some cases.

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 will cost you in interest.

When Personal Loans Are Not Your Best Option

While personal loans offer many borrowers an easy, flexible way to get funding for needs and wants alike, they aren’t without downsides. In fact, for some, personal loans may actually be a bad idea.

If your credit history doesn’t qualify you for a low-interest rate on your personal loan, consider alternative options such as a 0% introductory credit card offer or cash-out refinance.

Taking out a personal loan might also be a bad idea if you haven’t gotten your spending or budget management under control. 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. And paying for a vacation with a personal loan isn’t wise if you can’t afford to break up the vacation price tag and make the monthly payments moving forward.

Lastly, 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 currently allows you to deduct paid student loan interest each year when you file your income tax return. If you refinance your educational debt into a personal loan, you may no longer be able to take that deduction.

Do Personal Loans Hurt Your Credit?

Personal loans will impact your credit score. Whether that impact is positive or negative, however, depends on how you plan to use that loan and why you’re taking it out in the first place.

A personal loan can allow you to consolidate credit card debt and improve your credit score in several ways:

  • A personal loan is an installment loan, so debt on that loan won't hurt your credit score as much as debt on a credit card that's almost to its limit. This makes available credit more accessible, while also lowering your credit utilization over time.
  • By using a personal loan to pay off high interest credit card balances, you could lower your overall interest rate. This makes it easier to pay off the debt for less, improving your credit faster.

On the other hand, personal loans can also briefly negatively affect your credit. Like any loan, you will see a small drop in your score when you first take out your loan, due to related hard inquiries and the addition of a new account. But this will resolve itself over time as you repay the new loan.

What is a Good Rate for a Personal Loan?

The interest rate you’ll be offered for a personal loan will depend on your age, credit history, income, credit score and whether your loan will be secured or unsecured. Generally, though, personal loans can offer a better deal than credit cards and payday loans, making them at least worth a look.

For applicants with excellent credit (740+), the average interest rate on a personal loan is typically between 12 and 14%. Applicants with a lower credit score can often expect a much higher interest rate, or they may have trouble qualifying for a personal loan altogether.

Be sure to shop around with multiple lenders to ensure that you get the best possible terms available. You may also want to check with your local bank and any credit unions for which you qualify, as they may have the best offers.

Personal Loans: How Much Can I Get?

You will find that most lenders offer personal loans up to $45,000, though there are a few that may offer even more. How much money you can borrow, however, is dependent on your personal factors.

Your credit score and income will be the biggest factors in not only determining approval but also loan limits. The higher your score and the more money you make, the more a lender is likely to offer you.

Final Thoughts

While not for everyone, a personal loan can be a great way for some borrowers to consolidate debt, fund large purchases, and/or quickly improve their credit report. They offer lower interest rates than credit cards on average, with borrowing limits up to $45,000 or more.

As a typically unsecured product, personal loans are also easier to obtain than many other loan products, and don’t require collateral from borrowers. However, they may not be a better option than a 0% interest credit card or home equity line of credit, depending on your situation.

Before applying for a personal loan, be sure to check your credit report for any inaccuracies or concerns. Then, you can shop around for the best possible rates at terms that fit your budget.

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