The Pros and Cons of Personal Loans: A Complete Guide

Personal loans allow you to borrow money from a bank, credit union, or online lender for almost any purpose The funds can be used to consolidate high-interest debt, finance a large purchase, or cover unexpected expenses. But while personal loans offer flexibility, they also come with some drawbacks

In this comprehensive guide we’ll outline the key advantages and disadvantages of personal loans so you can determine if one is the right financing option for your situation.

What is a Personal Loan?

A personal loan provides an upfront sum of money that’s repaid in fixed monthly installments over a set repayment term. Loan amounts usually range from $1,000 to $100,000 and terms are generally between 1 and 7 years.

Unlike mortgages and auto loans, personal loans can be used for almost anything. Common uses include:

• Consolidating credit card or other high-interest debt
• Funding home renovations
• Paying medical bills
• Financing a vacation
• Making a large purchase
• Starting a business
• Paying tuition
• Covering emergency costs

Personal loans are installment loans, meaning you receive the full loan amount upfront and make regular payments until it’s fully repaid. This sets them apart from revolving credit like credit cards that lets you borrow as needed.

They also differ from payday and title loans in that they generally have lower interest rates and longer repayment terms.

Now let’s explore the key pros and cons of personal loans.

The Advantages of Personal Loans

Here are some of the main benefits of using a personal loan:

1. Predictable Payments

Unlike credit cards, personal loans have fixed interest rates and monthly payments. This makes it easy to budget for the loan each month. Your payment amount stays the same over the full repayment term.

2. May Have Lower Rates Than Credit Cards

For borrowers with good to excellent credit, a personal loan can provide lower interest rates compared to credit card rates. The average credit card interest rate is currently around 16% to 25%, while the average personal loan rate is 9% to 16%.

3. Flexible Spending

Personal loans offer more flexibility than other types of financing. While mortgages and auto loans must be used for specific purposes, you can use a personal loan for almost anything. This makes them helpful for covering unexpected expenses.

4. Fixed Repayment Terms

Personal loans have set repayment terms, usually between 1 and 7 years. This allows you to spread out a large expense over time. Paying off debt over a fixed term can also aid your credit scores by demonstrating responsible repayment habits.

5. May Improve Credit Scores

If you make consistent on-time payments, a personal loan can help build your credit history. Payment history is the biggest factor impacting your FICO and VantageScore credit scores.

6. Fast Funding

Many lenders provide access to loan funds within a few business days of approval. This makes personal loans helpful for managing financial emergencies that require quick access to cash.

7. Consolidate Debt

If you have high-interest debts like credit cards, consolidating them into a personal loan can potentially lower your interest costs. You’ll make just one monthly payment at a lower fixed rate instead of tracking multiple cards and varying rates.

8. No Collateral Needed

Personal loans are unsecured, so you don’t put any assets at risk as you would with a secured loan like a home equity loan or auto loan. There’s no collateral for the lender to seize if you default.

9. Pre-Approval Checks Don’t Hurt Your Credit

Many lenders allow you to check personalized pre-approval offers. Pre-approvals only require a soft credit check that doesn’t affect your scores. This allows you to easily compare loan offers.

The Disadvantages of Personal Loans

While personal loans offer advantages, they also come with some potential drawbacks:

1. Higher Interest Than Some Financing Options

Depending on your credit, personal loans may have higher rates than alternatives like home equity loans or lines of credit, which are secured by your home. Poor credit also leads to higher personal loan rates.

2. Origination & Late Fees

Most personal loans come with origination fees of 1% to 8% of the total loan amount. There are also late fees if you miss payments, usually around $15 to $30 per late payment.

3. Missed Payments Hurt Credit

If you make late payments or default on the loan, it can significantly damage your credit scores. Missed payments may also lead to collections calls and lawsuits if you cannot catch up.

4. Criteria May Be Difficult to Meet

You’ll generally need good to excellent credit and sufficient income to meet the lender’s standards. Insufficient income or a poor credit history may prevent approval.

5. Increases Debt Load

A new loan adds to your existing debts and raises your debt-to-income ratio. This can negatively impact your ability to qualify for future loans or lines of credit.

6. Locks You Into Repayment Schedule

Unlike credit cards, you can’t adjust your personal loan payments. The fixed schedule may be difficult to stick to if your financial situation changes. However, some lenders may allow adjustments if you contact them.

7. No Access to Additional Funds

Once you receive the lump-sum loan amount, you can’t access additional cash as you can with a credit card or line of credit. You would need to apply for a new loan if you require more funds.

8. Potentially High Payments

Depending on the loan amount, repayment term, and interest rate, monthly payments could be higher than minimum credit card payments. However, keeping credit card balances often leads to more interest costs over time.

Who Should (and Shouldn’t) Get a Personal Loan?

Personal loans can be helpful financing options for certain borrowers, while risky or expensive for others.

Here are some examples of who may benefit from a personal loan:

• Borrowers with good credit – Those with credit scores above 670 tend to qualify for the lowest rates, usually between 6% and 36%.

• Consumers looking to consolidate high-interest debt – Interest rates on credit cards average over 16%. Refinancing this debt with a personal loan at around 10% can save substantially on interest.

• Individuals who need extra funds for a large,planned expense – Personal loans allow you to finance expenses over set repayment terms.

• Homeowners wanting to complete renovations – Personal loans are an accessible way to fund home improvements compared to home equity loans, which have stricter eligibility requirements.

• Anyone with an urgent financial emergency – Fast access to funds makes personal loans helpful for covering unexpected costs like medical bills.

• People who want to build their credit history – Responsible repayment of a personal loan can help establish and improve credit.

Alternatively, personal loans may not be the ideal financing option for:

• Borrowers with bad credit – It’s hard to qualify if your credit scores are below 580. Interest rates are very high for those with poor credit.

• Individuals with existing high debt loads – Too much existing debt compared to your income will likely disqualify you.

• People who struggle with managing debts – Missed or late personal loan payments hurt your credit, and you cannot adjust repayment terms.

• Anyone needing small or short-term loans – Smaller or shorter-term loans often have higher rates. Alternatives like credit cards may cost less.

• Consumers who may struggle with fixed payments – Unlike credit cards, you cannot adjust personal loan payments if your finances change.

Carefully consider your financial situation to determine if you can manage the requirements and repayment terms before pursuing a personal loan.

Tips for Getting the Best Personal Loan Terms

Follow these tips to help secure the lowest rates and fees when taking out a personal loan:

• Have good credit – Rates are heavily influenced by your credit scores. Scores above 720 qualify you for the lowest rates.

• Compare multiple lenders – Each lender has its own loan offerings and underwriting criteria. Shopping around helps find your best option.

• Compare both online and local lenders – Online lenders sometimes offer lower rates but local banks/credit unions may provide better service.

• Consider secured loans – Putting up collateral like a savings account lowers risk for lenders and may lead to better terms.

• Opt for shorter terms – You’ll pay less interest with a shorter 1 to 3 year term compared to 5+ years.

• Make extra payments – Paying more than the monthly amount reduces overall interest costs. Most lenders don’t penalize early repayment.

• Ask about discounts – Some lenders offer discounts for setting up autopay, having an account with them, or other criteria.

• Watch out for origination fees – Ask if lenders charge upfront fees and factor those costs when comparing loan offers.

Doing research,