When Might a Personal Loan Be A Smart Choice: 3 Reasons to Consider a Personal Loan
They can be costly, but sometimes they’re your best choice
A personal loan can be utilized for almost any purpose. Some lenders might inquire about your intentions for the money, whereas others will simply want to ensure that you can repay it. Although personal loans aren’t cheap, they can be a practical solution in many situations. Here’s how to determine if one is suitable for you.
What is a Personal Loan?
A personal loan is a type of installment loan from a bank, credit union, or online lender. You borrow a fixed sum of money upfront (e.g., $5,000, $10,000) and repay it with interest in equal monthly installments over a set term (e.g., 12 months, 60 months).
KEY TAKEAWAYS
Personal loans are versatile and can be used for nearly any purpose. Unlike home mortgages and car loans, personal loans typically do not require collateral. Personal loans can be more affordable than credit cards and some other types of loans, but they can also be more costly than others.
How Personal Loans Work
A personal loan is generally an unsecured loan, meaning the lender does not require collateral—such as a home or car—to lend you money. However, because unsecured loans pose a higher risk to the lender, they often come with higher interest rates compared to secured loans. The exact rate you receive will depend on various factors, including your credit score and debt-to-income ratio.
Some banks do offer secured personal loans, where your collateral could be a bank account, car, or other property. These loans might be easier to qualify for and may have slightly lower interest rates than unsecured loans. However, as with any secured loan, failure to make payments could result in the loss of your collateral.
When to Consider a Personal Loan: 3 Reasons to Consider a Personal Loan
Here are some good reasons to consider taking out a personal loan:
Debt consolidation: If you have high-interest credit card debt, a personal loan can help you consolidate it into a single loan with a lower interest rate. This can save you money on interest and simplify your monthly payments. Be sure the interest rate on the personal loan is lower than your credit card interest rates to make this worthwhile.
Emergency expenses: Personal loans can be a good option for covering unexpected expenses, such as car repairs, medical bills, or appliance replacements. They are typically faster to get than other loans, such as home equity loans.
Large purchases: A personal loan can be a way to finance a large purchase that you can’t afford to pay for upfront, like furniture or home improvements. Just be sure the purchase will increase your value or well-being over the long term, and factor in the monthly payment to your budget.
Here are some things to consider before you get a personal loan:
Interest rates: Personal loan interest rates can vary depending on your creditworthiness. So it’s important to shop around and compare rates from different lenders before you borrow.
Fees: Be aware of any origination fees or other charges associated with the loan. These fees can add to the overall cost of the loan.
Your credit score: The better your credit score, the lower your interest rate will likely be. If your credit score is not good, you may want to wait to improve it before considering a personal loan.
Your budget: Can you afford the monthly payments? Make sure you factor in the loan payment to your budget before you borrow.
Here are some other options to consider besides a personal loan:
Savings: If you have the savings available, it’s always best to pay for things with cash to avoid interest charges.
Credit card with a 0% introductory APR: If you need to make a large purchase, you may be able to qualify for a credit card with a 0% introductory APR (Annual Percentage Rate). This can give you a certain amount of time to pay off the purchase without incurring interest charges. Just be sure you can pay off the balance before the introductory period ends, or you’ll be charged back interest on the entire amount.
Home equity loan or line of credit: If you own a home, you may be able to qualify for a home equity loan or line of credit. These loans allow you to borrow money against the equity in your home. However, they come with risks, as you could lose your home if you can’t make the payments.
How Do People Use Personal Loans?
People use personal loans for a variety of purposes, depending on their financial situation and needs. Here are some of the most common reasons people take out personal loans:
Debt Consolidation:
This is a common reason for using personal loans. If you have high-interest debt from credit cards, store cards, or other loans, a personal loan can help you consolidate it all into a single loan with a lower interest rate. This can simplify your monthly payments and potentially save you money on interest in the long run. Be sure the interest rate on the personal loan is lower than the average interest rate on your debts to make this worthwhile.
Emergency Expenses:
Life throws curveballs sometimes, and unexpected expenses can arise. A personal loan can be a way to cover these emergency costs, such as:
Car repairs: A broken down car can be a major financial burden. A personal loan can help you cover the repair costs and get back on the road.
Medical bills: Even with health insurance, you may still have out-of-pocket medical expenses. A personal loan can help you cover these costs and avoid going into medical debt.
Appliance replacements: Major appliances like refrigerators, washing machines, and ovens can break down unexpectedly. A personal loan can help you finance a replacement appliance without draining your savings.
Large Purchases:
Personal loans can be used to finance a large purchase that you can’t afford to pay for upfront, such as:
Furniture: You might need to furnish a new apartment or replace worn-out furniture. A personal loan can help you spread out the cost of these purchases.
Home improvements: Maybe you want to upgrade your kitchen or bathroom. A personal loan can be a way to finance these home improvement projects.
Other Uses:
Personal loans can also be used for other purposes, such as:
Education expenses: If you need help covering the cost of education or training, a personal loan may be an option.
Wedding costs: A personal loan can help cover wedding expenses if you don’t have the savings available.
What Can I Use a Personal Loan For?
Personal loans offer a flexible way to borrow money for a variety of purposes. Here’s a breakdown of some common uses and things to consider before you borrow:
Common Uses for Personal Loans:
Debt Consolidation: This is a popular option. If you have multiple high-interest debts like credit cards, a personal loan can help you consolidate them into one loan with a hopefully lower interest rate. This simplifies your payments and potentially saves money on interest in the long run, but only if the new rate is lower than your existing ones.
Emergency Expenses: Unexpected events happen. A personal loan can help cover sudden costs like:
Car repairs: A broken-down car can be a financial strain. A personal loan can get you back on the road.
Medical bills: Even with insurance, you might have out-of-pocket medical expenses. A personal loan can help cover them and avoid medical debt.
Appliance replacements: Major appliances can break down unexpectedly. A personal loan can help finance a replacement without draining your savings.
Large Purchases: Personal loans can be used to finance a purchase you can’t afford upfront, such as:
Furniture: You might need to furnish a new apartment or upgrade old furniture. A personal loan can help spread out the cost.
Home improvements: Maybe you want to renovate your kitchen or bathroom. A personal loan can be a way to finance these projects.
Other Uses:
Education expenses: If you need help covering the cost of a program or training, a personal loan may be an option.
Wedding costs: A personal loan can help cover wedding expenses if you don’t have the savings available.
Important Considerations Before Using a Personal Loan:
Interest Rates: Personal loan interest rates depend on your creditworthiness. Shop around and compare rates to get the best deal.
Impact on Budget: Factor in the monthly payments to your budget before you borrow. Make sure you can comfortably afford them.
Alternatives: Consider alternatives like using savings, a 0% APR credit card (for a limited time), or a home equity loan (if you own a home) to see if they might be a better fit for your situation.
Remember: Personal loans can be a useful tool, but borrowing comes with responsibility. Borrow wisely and only borrow what you can afford to repay.
When Should I not Take Out a Personal Loan?
While personal loans can be helpful for various situations, there are times when it might not be the best course of action. Here are some red flags to consider before taking out a personal loan:
You Can’t Afford the Monthly Payments:
This is the most critical factor. Personal loans come with fixed monthly payments that factor in both the principal amount borrowed and the interest. Make sure you can comfortably fit these payments into your budget without straining your finances. Analyze your income and expenses honestly before you borrow.
You’re Borrowing for Unnecessary Expenses:
Personal loans are not ideal for everyday spending or impulse purchases. The interest rates can be high, and you’ll end up paying more in the long run. Consider alternatives like cutting back on expenses or using a credit card with a low introductory APR (be sure you can repay the balance before the introductory period ends to avoid high-interest charges).
You Have Poor Credit:
If you have bad credit, you may qualify for a personal loan, but the interest rate will likely be very high. This can make borrowing very expensive. It might be better to focus on improving your credit score before considering a personal loan.
You Have Other Debt Options Available:
Depending on your situation, there might be better options than a personal loan. For example:
0% APR Credit Card: If you need to make a large purchase, you might qualify for a credit card with a 0% introductory APR on purchases. This can give you some time to pay off the purchase without incurring interest charges. Just be sure you can repay the balance before the introductory period ends to avoid high-interest charges on the remaining balance.
Home Equity Loan or Line of Credit: If you own a home and have equity in it, you may be able to qualify for a home equity loan or line of credit. These typically offer lower interest rates than personal loans. However, they come with the risk of losing your home if you can’t make the payments.
Here are some additional reasons to avoid personal loans:
You’re Unemployed or Have Unstable Income: If your job situation is uncertain, a personal loan can be risky. It’s important to have a stable income to ensure you can make the monthly payments.
You’re Pressured to Take Out a Loan Quickly: Don’t rush into a personal loan decision. Take time to shop around, compare rates, and consider alternatives. Avoid high-pressure sales tactics from lenders.
Remember: Personal loans can be a useful tool, but use them responsibly. By carefully considering these factors, you can make an informed decision about whether a personal loan is right for you.
The Bottom Line
Personal loans can be helpful in various situations. However, they are not inexpensive, and there may be better options available. If you’re thinking about getting one, Investopedia’s personal loan calculator can assist you in figuring out the cost and whether it aligns with your monthly budget.