If you need extra cash to pay for renovations, finance a wedding, or consolidate high-interest debt, consider a personal loan. Using an unsecured personal loans wisely can fill gaps in your budget without jeopardizing your home or other assets.
Like other loans, personal loan interest rates depend on your credit history, income and debt-to-income ratio and are not the right choice for everyone. Consider these pros and cons of personal loans before making a decision.
What is a personal loan and how does it work?
A personal loan is an installment loan that gives you a one-time fixed amount, usually between $1,000 and $50,000. Personal loans are usually unsecured, which means you don’t have to use collateral to get your funds. The term can be between 1 and 10 years. Personal loans can be used for almost anything, although some lenders may limit their use. Personal loan interest rates are fixed, so your interest rate does not change when you repay the loan.
Applying for a personal loan is similar to applying for a credit card. You will need to enter your personal information, financial information and details of the loan you need. Before you get approved, lenders run a rigorous credit check, which can temporarily lower your credit score. If your financial situation and credit score are good enough for the lender – usually you need a credit score around 600 – the lender will set your interest rate, loan amount and terms. You can sign up for a Bankrate account in less than 2 minutes to pre-qualify for a personal loan.
You receive all personal loan funds immediately and start repaying immediately. Until you repay the loan, your monthly payments are the same amount: a portion of your principal plus the cost of interest.
Benefits of Personal Loans
Personal loans can offer advantages over other types of loans. Here are some advantages of this type of financing over other options.
Because you receive the loan all at once, it may be easier to make a bulk purchase, consolidate debt, or otherwise use the loan all at once. You also get fixed interest rates and predictable monthly payments, making loans more manageable.
Fast financing time
Approval and disbursement times for personal loans are often short, making them useful in emergencies or other situations where quick cash is needed. Some personal lenders can deposit loan proceeds into your bank account as early as the next business day.
Flexibility and Versatility
Some loans can only be used for specific purposes. For example, buying a car is the only way you can use your money when you get a car loan. Personal loans can be used for a variety of purposes, from debt consolidation to paying medical bills.
If you want to finance a large purchase but don’t want to commit to how the money will be spent, a personal loan can be a good option. Before applying, check with your lender about the permitted uses of the loan.
Extended credit period
Unlike payday loans and other short-term loans that charge high interest rates, personal loans have terms ranging from 2 to 10 years, depending on the lender. As a result, you get decent monthly payments and plenty of time to pay back what you borrowed.
Easier to manage
Some people consolidate their debts with personal loans, such as B. Multiple credit card accounts. A personal loan with a single fixed monthly payment is easier to manage than multiple credit cards with different interest rates, payment dates, and other variables.
Borrowers who qualify for a personal loan with a lower interest rate than a credit card can simplify monthly payments and save money.
Disadvantages of Personal Loans
A personal loan may be a good option for some people, but it is not the right choice in all situations. Here are some negative factors to consider before taking out a personal loan.
Interest rates may be higher than other options
Personal loan interest rates aren’t always the cheapest option. This is especially true for borrowers with poor credit ratings, who may pay higher interest rates than credit cards or secured loans that require collateral.
Other entry requirements
Personal loan requirements may be stricter than other types of financing options. If you have bad credit or a short financial history, you have fewer lenders available to you. Also, some lenders don’t allow co-signers, which can be used to increase your chances of getting approved if you have very little credit history or a low credit score.
Fees and fines can be high
Personal loans can come with fees and penalties that drive up borrowing costs. Some loans have a processing fee of 1% to 6% of the loan amount. Fees covering loan processing can be applied to the loan or deducted from the amount paid to the borrower.
Some lenders charge a prepayment penalty if you pay off the balance before the end of the loan term. Before applying, review all fees and penalties for any personal loan you are considering.
Additional monthly payment
For personal loans, there are additional monthly installments. If you’re not careful, a personal loan may not take your budget into account when you borrow, and monthly payments can cause you to overdraw your account and put your budget in the red.
Debt burden increases
Personal loans can be debt consolidation tools like credit card balances, but they don’t address the root cause of debt. Paying off your credit card with a personal loan can free up your available credit limit. This allows those who overspend to charge more, rather than free themselves from debt.
The payment amount is higher than the credit card
Credit cards have low minimum monthly payments and no time limit to pay the balance in full. Personal loans require higher fixed monthly repayments and must be repaid at the end of the loan term.
When you consolidate credit card debt into a personal loan, you have to accommodate for higher payments and loan repayment schedules, or risk defaulting on payments.
How to determine if a personal loan is right for you
Personal loans are an attractive option when you need to make quick money. Here’s how you can tell if a personal loan is right for your situation:
- You need money fast. For many lenders, especially those operating online, funding is available within days.
- You have a good credit history. The lowest rates are reserved for borrowers with good credit ratings.
- They want to pay off high-interest debt. A personal loan is a great way to consolidate and pay off expensive credit card debt.
- You use this money for necessary expenses. Paying emergency expenses or remodeling your home are other good reasons to use a personal loan.
However, personal loans are not a good idea for everyone. After all, personal loans are still a form of debt. Here are some reasons why a personal loan might not be right for you:
- You have no viable means. It can be tempting to take out a loan for additional funding. However, if you don’t plan how to use those funds, you risk spending money on unnecessary things and paying unnecessary interest.
- They have a habit of overspending. Paying off your credit card with a personal loan may not make sense if you start building a new credit card balance right away.
- You can’t afford your monthly payments. Consider the personal loan repayment schedule and monthly payments. Use a personal loan calculator to determine if you can afford the monthly payments for the term you will use to repay.
- You don’t need the money urgently. It may make sense to build savings for bulk purchases rather than taking out a personal loan and paying interest over many years.
Alternatives to Personal Loans
In some cases, a personal loan is not the smartest option.
If you have enough home equity, you can mortgage it through a home equity loan or a home equity line of credit (HELOC). A home equity loan is an installment loan, and a HELOC works much like a credit card. One disadvantage of a home equity loan, or HELOC, is that your home is used as collateral. If you default on your loan, you could lose your home in foreclosure.
Another option for personal loans is to offer the service of transferring credit card balances. A good balance transfer offer can save you money if you pay off your balance before the promotional period ends. You can use our credit card balance transfer calculator to see how long it will take to pay your balance.
If your financial constraints are the result of overspending, a more realistic spending plan is a more viable option. Otherwise, you may accumulate excessive debt that may take time to get rid of.
Before you take out a personal loan, make a plan for how you will use the money and how you will pay it back (including interest). Weigh the pros and cons of personal loans versus other financing options. Explore alternatives like home equity loans, HELOCs, or credit card balance transfers. Use the bank’s interest rate calculator to determine the best loan option for you.
When considering a personal loan, get quotes from multiple lenders to compare interest rates and loan terms. Don’t forget to read the fine print, including fees and penalties. With all the data in hand, determine if the pros of a personal loan outweigh the cons before committing.
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