The Pros and Cons of Personal Loans | Bank rate (2023)

Personal loan funds can be used for various purposes, including debt consolidation and medical expenses. It can be a good solution when you need money fast: some lenders can fund your account as soon as the next business day. Also, average interest rates are often lower than other forms of debt, such as B. Credit cards.

But like all financial products, personal loans also have disadvantages. For example, some lenders charge high fees, which can add significantly to your loan costs. Before completing one, you should weigh the pros and cons to determine if this is the right financing option for you and consider the alternatives.

Pros and cons of personal loans

As with any other form of debt, there are pros and cons to consider before applying for a personal loan. Here's what you need to know before you sign the dotted line.

Benefits of personal loans

Personal loans can offer advantages over other types of loans. Below are some advantages of this type of financing compared to other options.

a lump sum

Because you receive a one-time loan payment, it can be easier to make large purchases, consolidate debt, or use the loan all at once. You also get a fixed interest rate and a predictable monthly payment, making it easier to manage the loan.

Why it's important: Receiving a one-time payment at a fixed rate can be easier to manage and help you avoid late payments.

Fast funding times

Personal loans generally have fast approval and payment times, making them useful for emergencies or other situations where you need cash fast. Some personal lenders can deposit loan funds into your bank account as soon as the next business day.

Why it matters: If you need money fast, a personal loan can be a good financing option.

No security obligation

Unsecured personal loansYou do not need a guarantee to be approved. That means you don't have to give up your car, home, or any other asset as a guarantee that you'll pay it back. If you can't repay the loan on the terms agreed with your lender, you face significant financial and credit consequences. But unlike a secured personal loan, you don't have to worry about losing a home or car as a direct result.

Why It Matters: With an unsecured loan, a lender can't take your collateral for default on the loan, at least without court approval.

lower interest rates

Personal loans usually have lower interest rates than credit cards. As of February 2023, the average interest rate for personal loans was 10.56 percent, while the averagecreditcardtentarifwas 19.91 percent. Consumers with excellent credit histories may qualify for personal loans with interest rates of approximately 10.73 percent to 12.5 percent. You may also qualify for a loan amount higher than your credit card limit.

You may be able to save on interest if you have good credit and get a personal loan instead of a credit card.

flexibility and versatility

Some loans can only be used for a specific purpose. For example, buying a car is the only way to use the funds when you get a car loan. Personal loans can be used for many purposes, from debt consolidation to paying medical bills.

A personal loan can be a good option if you want to finance a major purchase but don't want to commit to using the money. Before applying, check with your lender about allowable uses for the loan.

Why it matters: A personal loan can be a good solution when you need to borrow money for almost any reason.

Extended Credit Periods

Unlike short-term loans like payday loans and others that charge high interest rates, personal loans range from 2 to 10 years, depending on the lender. As a result, you get a decent monthly payment and enough time to pay off what you borrowed.

Why it matters: Longer loan terms can make borrowing money more affordable. Remember, the longer the term of your loan, the more interest you will pay over the life of the loan.

Easier to manage

Some people take personal loans to consolidate debt, 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 their credit card can speed up their monthly payments and save money.

Why it matters: Qualifying for a personal loan with a lower interest rate than your current debt can save you thousands of dollars in interest.

Disadvantages of personal loans

Personal loans may be a good option for some, but they are not the right choice in all situations. Here are some negatives to consider before getting a personal loan.

Interest rates may be higher than alternatives

Personal loan interest rates are not always the cheapest option. This is especially true for borrowers with low credit scores who can pay higher interest rates than credit cards or a secured loan that requires collateral.

Why it matters: The smaller your loan, the more likely it is that a lender will charge you a high interest rate. As a result, you could end up paying thousands of dollars more in interest than someone with good credit.

Other admission requirements

Personal loans may have more stringent requirements than other types of financing options. If you have bad credit or a short financial history, there are fewer lenders available to you. Also, some lenders do not allow cosigners, which can be used to increase your chances of approval if you have minimal credit history or a low credit score.

Why it matters: Qualifying for a personal loan can be more difficult if you have bad credit.

Fees and penalties can be high

Personal loans may have fees and penalties that can increase the cost of the loan. Some loans come with processing fees ranging from 1 to 6 percent of the loan amount. Fees that cover loan processing may be applied to the loan or deducted from the amount paid to the borrower.

Some lenders charge prepayment penalties if you pay off the balance before the end of the loan term. Before you apply, review all the fees and penalties for any personal loan you're considering.

Why it matters: Fees and penalties can add significantly to your loan costs.

additional monthly payment

With a personal loan, there is an additional monthly fee. If you're not careful, a personal loan can create term problems with your budget if it isn't accounted for when you borrow and the monthly payment causes you to overdraw your account and put your budget in the red.

Why it matters: A personal loan can hurt your budget if you borrow more than you can afford.

Increased debt burden

Personal loans can be a debt consolidation tool like credit card balances, but they don't address the root cause of the debt. Paying off your credit cards with a personal loan frees up your available credit limit. This allows those who overspend to collect more instead of working their way out of debt.

Why it's important: While getting a personal loan can help you consolidate high-interest debt, it can lead you deeper into debt if you don't address bad spending habits.

Higher payments than credit cards

Credit cards come with low minimum monthly payments and no time limit on paying off your balance in full. Personal loans require a higher fixed monthly payment and are due at the end of the loan term.

When you consolidate credit card debt into a personal loan, you must accommodate the higher payments and repayment schedule of the loan or risk missing payments.

Why it matters: Depending on your finances, higher monthly payments may be more difficult to manage. As a result, you may be at greater risk of defaulting on the loan.

Potential credit damage

If you don't keep up with your monthly payments or fail multiple applications, personal loans can have an adverse effect on your credit score. When you apply for a loan, the lender runs a strict credit check that lowers your score by a few points, and the amount of debt you owe compared to your annual income can affect your credit score.

However, the initial deterioration does not last long with a positive payment history and your score will increase as you make monthly payments and pay down your debt. Your payment history makes up the largest percentage (35 percent) of your Fico Score, and your amounts owed make up 30 percent.

Why It Matters: Poor payment history and a high debt-to-income ratio are likely to result in a significant drop in credit scores, which can make it harder to get approved for things like a mortgage and car loan.

How to decide if a personal loan is right for you

Personal loans are an attractive option when you need fast money. Here's how you can tell if a personal loan might make sense for your situation:

• You need the money fast. With many lenders, especially those that operate online, funds can be available in a matter of days.
• You have a strong credit history. The lowest interest rates are reserved for borrowers with good credit scores.
• They want to pay off high-interest debt. Personal loans are a great way to consolidate and pay off expensive credit card debt.
• You use the money for necessary expenses. other goodReasons to use personal loansThis includes paying emergency expenses or remodeling your home.

However, personal loans are not a good idea for everyone. Here are some reasons why a personal loan may not be right for you:

• You have no viable end to the means. It can be tempting to take out a loan to have additional funds available. But if you don't have a plan for how the funds will be used, you risk wasting money and paying unnecessary interest on things that aren't essential.
• They have a habit of overspending. Paying off your credit cards with a personal loan may not make sense if you start racking up a new credit card balance right away.
• You cannot afford the monthly payments. Consider the repayment schedule and monthly payments for a personal loan. use onepersonal loan calculatorto determine if you can afford the monthly payments for the term you will be paying.
• You don't need the money urgently. It may make sense to accumulate your savings for a big purchase instead of taking out a personal loan and paying interest for many years.

Alternatives to personal loans

If you think getting a personal loan isn't right for you, here are some alternative options to consider:

• mortgage loan. If you have enough equity in your home, you can mortgage it with a home equity loan. A home loan works much like a personal loan in that it has fixed payments and interest rates. But one major downside is that if you don't pay back the loan as promised, a lender can foreclose on your home.
• Home Equity Line of Credit (HELOC). Another way to tap into your home's equity is to get a HELOC. A HELOC works like a credit card: it usually comes with a variable interest rate and you can borrow money when you need it. Similar to a home equity loan, a lender can foreclose on your home if you default on the loan.
• Credit card with 0% APR. If you have good to excellent credit, you may qualify for a credit card with an interest-free promotional period. As long as you pay off the loaned item before the end of the promotion period, you can refrain from paying interest. However, you are responsible for paying interest on the remaining balance at the card's standard APR, which can be high.

bottom line

Before taking out a personal loan, make a plan for how you will use the money and how you will pay it back (with interest). Weigh the pros and cons of a personal loan versus another financing option. Explore alternatives like a home equity loan, HELOC, or credit card balance transfer. use oneBank rate calculationr to help you determine the best loan option for you.

When considering a personal loan, get quotes from several lenders to compare interest rates and loan terms. Don't forget to read the fine print, including fees and penalties. Once you have all the facts, decide if the benefits of a personal loan outweigh the drawbacks before committing.