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Key takeaways
- Personal loans can be used to consolidate debt, finance large purchases, or cover unexpected expenses with potentially lower interest rates than credit cards.
- It’s important to shop around and prequalify for a personal loan. Compare interest rates, amounts, fees, terms, and more to make sure you get the best loan for you.
- While taking out a personal loan can initially hurt your credit score due to the hard inquiry, responsible repayment can positively affect your score over time.
Personal loans can be helpful financial tools. You can use them for home improvement projects, unexpected medical bills, to help pay off high-interest debt, or anything you choose. If you work with a reputable lender, find a loan with favorable terms, and have a repayment plan in place, then getting a personal loan can be a smart choice. If on the other hand, your loan comes with high interest rates and inflexible terms, it might be better to look for more affordable options. Before you take out a personal loan, weigh the pros and cons to see if it’s the right decision for you.
What is a Personal Loan?
A personal loan is a type of unsecured loan, which means it doesn’t require collateral like your home or car. It’s a loan that you can use for a variety of personal reasons, including consolidating debt, financing a large purchase, or covering an emergency expense. Typically, personal loans are repaid in equal monthly payments or installments over a set period, often ranging from one to seven years. They come with interest rates that range from 6% to 36% and amounts that vary from $500 up to $100,000. The interest rate you’re given depends on your credit score and other factors. If your score is on the low end, you can expect to pay higher interest.
When is a Personal Loan a Good Idea?
Personal loans can be a good option if you want to consolidate high-interest debt, finance a big purchase, make a home improvement (and increase your property’s value), or need cash to cover a financial emergency. Personal loans are often a better choice than credit cards which come with high interest rates. Paying off your debt – especially credit card debt – with a personal loan can potentially lower your interest rate, streamline multiple debts into one manageable monthly payment, and save you thousands. Lenders often offer funding as fast as one day. Before you decide to go with a personal loan, make sure that your income is stable enough to afford a few years of monthly payments and that you can get a lower interest rate than your credit card.
When is a Personal Loan a Bad Idea?
Personal loans aren’t always the right choice. They’re not good to use for non-essential purchases like a dream vacation, luxury wedding, or the latest tech gadget. The pleasure of the experience or new item will wear off and you’ll be left with more debt. If you have a hard time managing debt or only qualify for high-interest loans, then reconsider since the cost of borrowing might outweigh the benefits. Be aware of any extra fees like an origination fee or a prepayment penalty before you take on a loan.
How Can a Personal Loan Affect My Credit Score?
Applying for a personal loan results in a hard inquiry on your credit report. This can temporarily cause your score to drop, especially if you apply for multiple loans at once. On the other hand, regular, on-time payments can improve your credit. Payment history accounts for 35% of your credit score, so on-time payments will make it go up but if you miss a payment you may see your score go down. Additionally, if you’re using the loan for debt consolidation, you may lower your credit utilization ratio, another plus for your credit score. And a personal loan will help diversify your credit mix, a small but important scoring factor.
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How to Choose the Best Personal Loan
When you’re in the market for a personal loan it pays to shop around. Many lenders will let you prequalify to check potential rates and terms without affecting your credit score. Prequalify for as many loans as you can and then compare lenders. Analyze their interest rates, loan amounts, associated fees, loan terms, customer service, reputation, and types of loans available to ensure you get the best deal. Perhaps the lender has a mobile app that lets you track the loan or flexible payment schedules so you can change due dates or defer payments. If you want a debt consolidation loan, some lenders will send your loan proceeds directly to your creditors simplifying the process. Shop around and find the loan that costs the least.
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What are Alternatives to Personal Loans?
Credit Cards
For smaller or short-term expenses, a credit card with a 0% introductory APR can be a good option. Just make sure you can pay off the balance before the promotional period ends or else you’ll have to pay interest from the beginning. Lots of credit cards also offer rewards so you can get some cash back or travel points with your purchases.
Home Equity Loans
If you’re a homeowner, consider a home equity loan. It is similar to a personal loan. Once again you are given a lump sum with a fixed interest rate and installment payments. The interest rates are often lower than a loan or credit card, but your property becomes collateral. If you fail to repay, the lender can foreclose on your home.
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Savings
The best alternative is of course to save your money. Whenever possible, saving for a big purchase is the most financially sound approach. It avoids the risks and costs associated with borrowing and can save you thousands on interest payments.
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Final Thoughts
Personal loans are popular and an easy way to get funding for whatever you need. If you have good credit and can manage loan payments it’s hard to go wrong. For those who don’t fit that description, personal loans can be costly and should be carefully considered. No matter your credit score and financial management skills, always make a repayment plan, compare loan terms, and read the fine print before you commit to a loan.
