Personal loans can be a useful way to obtain extra money when you need it. For example, if you run into an emergency, you might not have the funds available to meet your needs. If you’re planning a large life event like a wedding, you may want a little extra cash to finance it. In these cases, and many others, personal loans can come to the rescue.
There are many benefits to obtaining a personal loan. They can be a helpful way to make big purchases, pay an unexpected bill, and consolidate debt.
- A personal loan is an amount of money that a lender (a bank, credit union, or state-licensed lender) gives to a borrower. The borrower then has to repay the loan plus interest and fees over a set period of time.
- There are many important benefits of obtaining a personal loan, including debt consolidation, a predictable repayment schedule, and building your credit history.
- To take out a personal loan, you’ll need to review your financial situation, find the right lender for you, gather all required documentation, and submit your application.
If you’re wondering how a personal loan can be of help in your life, we’ve made a list of ways in which personal loans can be beneficial.
What Are the Benefits of Obtaining a Personal Loan?
Here are seven benefits of taking out a personal loan.
1. They help you pay for emergency expenses without draining your savings
Life happens, and sometimes you really need access to emergency funds. Medical bills, car repairs, or purchasing a new appliance may exceed or totally deplete your savings. This can be concerning, leaving you vulnerable to additional, unexpected future costs.
Taking out a personal loan can help you cover the costs you need to, leaving you a cushion in your savings.
When you get a personal loan, it can be used for a variety of personal reasons. For example:
- Cover unexpected expenses: Life is full of surprises, and large expenses can be unpredictable. When you suddenly need to pay for an expense, a personal loan can be a great way to do it.
- Finance a large purchase: A personal loan may be the best option for major purchases, especially if you qualify for an APR that’s lower than your credit card. You can use the loan to pay for home improvements, car repairs, or even a family vacation.
- Consolidate debt: Many unsecured personal loans are used to combine multiple debts into one loan with easy-to-manage payments and a lower interest rate.
2. They enable you to consolidate high-interest debt
If you have credit card debt to repay, you’re likely racking up high levels of interest each month. If interest is accumulating on multiple credit cards, it’s even more complicated to get ahead of your debt.
Personal loans enable you to better manage your debt. You can borrow money with a personal loan and use this to pay off your credit card debt. This consolidates the money you owe, gives you a fixed payment each month and you’ll have an end date for when the loan will be fully paid off.
Additionally, you can often find personal loans with lower interest rates than credit cards. This allows you to pay off your debt faster and save you money in the long run.
3. You can use them to finance your wedding or dream vacation
When life’s biggest events come around, you may not always be able to afford exactly what you have dreamed of. Whether it’s your wedding, honeymoon, or dream vacation, personal loans can help you pay for it.
4. They have predictable payment schedules
Once you take out a personal loan, the term and interest rate are fixed. Having a set amount to pay makes it much easier to plan your finances. Compared to credit cards, which have a revolving monthly payment that depends on how much you spend, personal loan payments are much more predictable.
When paying back a loan, it’s important to know a few details:
- The total amount you have to pay back
- How much money you have to pay each month?
- How long you’ll be making payments
When you get a personal loan, all this information is provided by the lender. This allows you to know exactly how much you owe and when you owe it.
5. Personal loans are flexible in their uses
Flexibility is one of the most beneficial aspects of a personal loan. Car loans are for cars, mortgages are for homes, but personal loans can generally be spent on pretty much anything you’d like. The lack of restriction gives borrowers the freedom to use the money how they need – whether that be starting a business, financing a wedding, or consolidating debt.
6. They may help you build your credit score
If you are working on building your credit score, a personal loan may help.
Personal loans can help build multiple aspects of your credit score, including your credit mix – the types of credit you have money borrowed on, the length of your credit record, and your credit utilization ratio. When you first take out a personal loan, your credit score may temporarily dip. However, as you pay back the loan on time every month, your credit score will build.
You may want to be cautious, though. If you don’t already have decent credit, you may not be able to take out a personal loan with a very good interest rate. High APR and fees can put you into a situation where you cannot afford to pay back the loan, overall damaging your credit score.
Remember that if you are not able to pay your monthly payments, your credit score will drop, defeating your original intentions.
7. You can borrow large sums of money than a credit card
Depending on your specific financial situation, your credit cards may have relatively low monthly limits. This can make it challenging to use a credit card to finance large purchases. This is where a personal loan can come in.
A personal loan can range in amount, usually around $1,000 to $10,000. However, some lenders may offer loans as small as $100 or as large as $100,000. These flexible sums let you finance higher costs than a credit card may allow, usually at lower interest rates.
Is there anything else you need to know about personal loans?
Personal loans are advantageous, but there are some things you might want to consider.
First and foremost, the best rates are typically reserved for those with excellent credit scores. Lenders will look at your credit history to determine your creditworthiness.
They often have a pre-approval process, which allows you to determine without consequence whether you’re eligible for a good rate. Lenders run a soft inquiry, which doesn’t harm your credit score. If you currently have poor credit, you can work to build a good credit score. In addition to your credit report, lenders may also look at your debt-to-income ratio to determine whether they want to lend to you.
Second, it’s important to make your loan payments on time. If you don’t, you’ll be charged penalties, increasing the amount you owe the lender. Missed payments are a violation of your loan terms and will impact your financial standing and credit, making it more challenging to obtain future funding.
Lastly, note that there are a few different types of loans available. While you may see general personal loans, you may also see debt consolidation loans or home equity lines of credit (HELOCs).
Debt consolidation loans are for paying down high-interest debt. In these cases, you may not receive the funds upfront. Instead, your lender will pay down your existing debt, and you’ll repay the lender.
HELOCs are a type of secured loan in which you put up the equity in your home as collateral. If you default on the loan, your lender can seize your home. Home equity loans can still be advantageous, but it’s smart to know what you’re getting yourself into before opening one.
The pros and cons of personal loans
Pros of a personal loan
Personal loans can offer benefits over other types of loans. Below are a few advantages of using this type of financing over other options.
1. Flexibility and versatility
Some types of loans can only be used for a certain purpose. For example, if you take out a car loan, the only way to use the funds is to purchase a vehicle. Personal loans can be used for many purposes, from consolidating debt to paying off medical bills.
If you want to finance a major purchase but don’t want to be locked into how you use the money, a personal loan can be a good alternative. Check with your lender on the approved uses for the loan before applying.
2. Lower interest rates and higher borrowing limits
Personal loans often come with lower interest rates than credit cards. As of September 2021, the average personal loan rate was 10.46 percent, while the average credit card rate was 16.27 percent. Consumers with excellent credit history can qualify for personal loan rates in the range of 6 percent to 8 percent. You may also qualify for a higher loan amount than the limit on your credit cards.
3. No collateral requirement
Unsecured personal loans don’t require collateral for you to get approved. This means you don’t have to put your car, home, or other assets up as a guarantee that you’ll repay the funds. If you’re unable to repay the loan based on the agreed-upon terms with your lender, you’ll face significant financial consequences. However, you don’t have to worry about losing a home or a car as a direct result.
4. Easier to manage
One reason some people take out personal loans is to consolidate debt, such as multiple credit card accounts. A personal loan with a single, fixed-rate monthly payment is easier to manage than several credit cards with different interest rates, payment due dates, and other variables.
Borrowers who qualify for a personal loan with a lower interest rate than their credit cards can streamline their monthly payments and save money in the process.
Drawbacks of personal loans
Personal loans can be a good option for some, but they are not the right choice in all situations. Here are a few negatives to consider before taking out a personal loan.
1. Interest rates can be higher than alternatives
Interest rates for personal loans are not always the lowest option. This is especially true for borrowers with poor credit, who might pay higher interest rates than with credit cards.
If you have sufficient equity in your home, you can borrow against it using a home equity loan or a home equity line of credit (HELOC). A home equity loan is an installment loan, while a HELOC works similarly to a credit card. One downside to having a home equity loan or a HELOC is that your home is used as collateral. If you default on the loan, you risk losing your home to foreclosure.
Credit card balance transfer offers are another alternative to personal loans. You can save money with a good balance transfer offer, provided you pay the balance off before the special offer period ends. Our credit card balance transfer calculator will help you see how long it will take to pay off your balance.
2. Fees and penalties can be high
Personal loans may come with fees and penalties that can drive up the cost of borrowing. Some loans come with origination fees of 1 percent to 6 percent of the loan amount. The fees, which cover loan processing, can either be rolled into the loan or subtracted from the amount disbursed to the borrower.
Some lenders charge prepayment penalties if you pay the balance off before the end of your loan term. Before applying, review all fees and penalties of any personal loans you are considering.
3. Higher payments than credit cards
Credit cards come with small minimum monthly payments and no deadline for paying your balance off in full. Personal loans require a higher fixed monthly payment and have to be paid off by the end of the loan term.
If you consolidate credit card debt into a personal loan, you’ll have to adjust to the higher payments and the loan payoff timeline or risk defaulting.
4. Can increase debt
Personal loans can be a tool for consolidating debt such as credit card balances, but they do not address the cause of the debt. When you pay your credit cards off with a personal loan, it frees up your available credit limit. For over spenders, this offers an opportunity to rack up more charges rather than free themselves from debt.
Is a personal loan right for you?
Personal loans are an attractive option if you need quick cash. Here’s how to discern whether a personal loan might make sense for your situation:
- You need the funds quickly. With many lenders, especially those that operate online, funds can be made available in a matter of days.
- You have a strong credit score. The lowest interest rates are reserved for borrowers who have good credit.
- You want to pay off high-interest debt. Personal loans are a good way to consolidate and pay off costly credit card debt.
- You’ll use the funds toward necessary expenses. Other good reasons to use personal loans include paying for emergency expenses or remodeling your home.
However, personal loans are not a good idea for everyone. After all, personal loans are still a form of debt. Below are a few reasons a personal loan might not be right for you:
- You have a habit of overspending. Paying your credit cards off with a personal loan may not make sense if you’ll immediately begin building up a new credit card balance.
- You can’t afford the monthly payments. Consider a personal loan’s repayment timeline and monthly payments. Use a personal loan calculator to determine whether or not you can afford the monthly payments for the term you’ll spend paying it off.
- You don’t need the money urgently. It might make sense to build up your savings to pay for a large purchase instead of taking out a personal loan and making payments with interest for many years.