A traditional personal loan is a popular way to borrow money to cover emergency expenses, consolidate debt, and more. Funds from a personal loan are typically deposited as a lump sum into your bank account soon after you’re approved. Oftentimes, the best personal loans advertise funding for qualified applicants as quickly as the same business day.
But, personal loans aren’t always a good idea. Here are the need-to-know pros and cons of personal loans and how to evaluate if such a loan is right for your situation.
Pros of personal loans
Use the funds for (nearly) anything
Personal loans are extremely flexible in how consumers can use them. So long as a purchase isn’t against the law, you can spend the money just about any way you like—from medical expenses to car repairs to home renovations.
That said, some lenders explicitly forbid you from using your funds for a select few purposes. For example, you sometimes cannot take out a loan from a bank to consolidate debt you owe with that same bank. You also generally can’t use a personal loan as a down payment when buying a house.
Save on high-interest debt
Personal loans tend to come with more reasonable interest rates than some other financing options like credit cards. For this reason, a personal loan can be a smart way to consolidate multiple credit card debts to escape high APR and help you pay off your balances much sooner. Just make sure you don’t add more credit card debt after paying off your card(s) with a loan, otherwise you’ll be stuck in a difficult-to-escape cycle.
Generally less risky than other loan types
Most personal loans are unsecured, meaning you aren’t required to submit any sort of security deposit to open the account. If you default on your loan, your credit may tank—but your property isn’t in jeopardy as it may be with, say, a home equity loan which uses your house as collateral.
Also, when comparing a personal loan vs. a deferred interest financing plan, know that the latter comes with the risk of a massive interest charge if you don’t fully pay off what you owe within the financing period. Unlike true 0% intro APR offers—which you’ll find on some credit cards—deferred interest financing means you can be charged interest on the full purchase amount from the date of purchase if you haven’t zeroed out your debt by the promotional period’s end date.
If you’ve ever been offered a CareCredit application as an option to finance a medical or veterinary expense, you may be familiar with deferred interest plans. The CareCredit credit card often provides promotional financing offers with the language “No Interest if Paid in Full,” which signals deferred interest.
While you will pay interest on a personal loan, the rate is likely to be lower than what you’d be assessed if you incurred a deferred interest charge at a high APR.
Improve credit score
Getting a personal loan can help to improve your credit score in a few ways.
First, it can give you more opportunity to make on-time payments (the weightiest factor of your credit score). Another loan means more chances to exhibit positive credit habits.
Also, it can help you to eliminate revolving loan debt, such as credit card balances. Because installment loans don’t count against your credit utilization, this can dramatically lower your amounts owed. If your credit utilization is high—more than 30% of what’s available across your credit cards, for example—your credit score might increase considerably after just a month or two of relocating that credit card debt to a personal loan.
Finally, taking out a personal loan can improve your credit mix (the type of credit accounts on your profile) which accounts for 10% of your FICO Score.
Of course, the amount a personal loan might help your credit score varies by your specific circumstances and current credit profile. It’s not primarily a tool for rebuilding a low credit score. But, managed responsibly, a personal loan may very well boost your score in the long run.
Pay off debt on a set timeline
One of the key advantages of a personal loan is that it’s installment financing, not revolving financing. With revolving credit, which mainly refers to credit cards, you borrow as you need and repay as you go. That makes it easy to keep taking on more debt.
And, as credit cards allow customers to make just a minimum payment—the bulk of which only goes toward covering interest charges—rather than paying in full, such debt can end up as an albatross around your neck for years. A personal loan has a concrete repayment timeline the borrower must meet and doesn’t allow for new debt to be casually added.
For that reason, a personal loan is likely the better choice for someone who may struggle with paying off their credit cards in full and who is striving to become debt free.
Cons of personal loans
Interest and fees
Perhaps the most obvious downside to a personal loan is the interest you’ll incur as you pay it off. Interest is unavoidable with installment loans, as it’s included as part of your monthly payment. Still, you can minimize the amount you lose by paying off your loan as quickly as possible.
Some lenders charge additional fees, as well. These may include origination fees, administrative fees, and early payoff fees. Before you sign on the dotted line, make sure you know all fees and penalties associated with your would-be personal loan.
Temporary credit ding
When you apply for a loan, the financial institution will perform a hard credit inquiry to decide if you’re creditworthy. This results in a temporary drop in your credit score. Again, if you manage your loan responsibly, your credit will bounce back quickly—but it’s still worth noting the brief negative effect that results from opening a personal loan.
Potential to exacerbate debt
A personal loan isn’t a solution to an overspending problem. In fact, it can be extremely detrimental.
For example, if you take out a debt consolidation loan to nuke your credit card debt, you’re opening yourself up to the possibility of accruing even more debt if you don’t tamp down the credit card spending. It’s also not recommended to open a personal loan for recreational purchases such as a vacation or an expensive but non-essential piece of equipment for a hobby.
All to say, a personal loan may not be right for you if you haven’t first taken thorough stock of your finances, implemented a budget, and taken realistic steps to curb impulse spending.
Alternatives to personal loans
If you’ve got an expense for which you don’t currently have the money, a personal loan isn’t the only way to go. In some situations, it could make sense to consider the following options instead:
- Credit cards. While credit cards typically come with much higher interest rates than a personal loan, it could make sense to put your purchase on a credit card with a 0% intro APR period. Some cards offer an interest-free window up to 24 months. Then, once the promotional period ends, interest begins accruing on any remaining balance.
- Borrow against your home equity. Again, a home equity loan or home equity line of credit (HELOC) has more dramatic consequences than an unsecured loan. But they often come with lower interest rates and—depending on your amount of equity—higher borrowing limits.
- Buy Now Pay Later (BNPL). If you can pay off your purchase within a few months, you may consider a BNPL option through providers like Affirm. These allow you to split your expense over multiple interest-free payments as long as you meet requirements. But be aware if you don’t meet your obligations, you could damage your credit score and potentially even incur deferred interest. It’s key to read the fine print of the BNPL plan you’re considering.
- Borrow from a friend or family member. If you’ve got the implicit trust of your friends and family, you may ask about borrowing money from them instead of formally applying for a loan. You won’t have to worry about creditworthiness, and you may save on interest payments, too. But make sure to clearly outline expectations for when you’ll pay back what you’ve borrowed, and stick to the plan, so as to avoid damaging these important relationships.
The takeaway
Personal loans can be extremely valuable financial tools to move forward from the occasional financial bind. You can use the borrowed funds for nearly anything—including consolidating existing high-APR debt, such as credit card balances, to potentially save hundreds or thousands of dollars in interest you might have accrued.
Just recognize that personal loans aren’t always a good idea. Don’t take out a loan for non-essential expenses, or if you haven’t factored the repayment into your budget plan.
Frequently asked questions
What fees should I expect with a personal loan?
Upon account opening, some lenders charge upfront fees like origination, administrative, and account opening fees. Some also charge if you pay off your account early. Aside from that, you can expect to pay late fees if you fail to make on-time payments.
How fast can I get approved and receive funds from a personal loan?
Once you’re approved for a personal loan, you’ll typically receive funds within a few days. Some lenders advertise the possibility of money-in-hand as soon as the same business day.
Are personal loans a good option for emergency expenses?
Personal loans can be a good option for emergency expenses if your alternative is to swipe a credit card or pull from savings that you’re uncomfortable touching. Personal loans often come with notably lower APR than high-interest options like credit cards.
Can I get a personal loan with bad credit?
It’s possible to get a personal loan with bad credit, though you’re likely to get less-than-desirable interest rates and less borrowing power. If you’ve got bad credit and need a loan, your best bet may be a secured loan for which you must present collateral. We must stress that it’s especially important to know your budget—and to have a realistic plan for making all your payments on time—when you take out a secured loan.
