A personal loan is an unsecured loan that you can use for any purpose, including debt consolidation, emergency expenses, home improvements, and more. Because of this flexibility and lack of collateral, many find personal loans appealing, since you can use them for various financial needs.
However, while a personal loan can grant you the funds you need, it can also be dangerous to your finances if taken out imprudently. An improperly managed loan can put your credit score and overall financial standing at risk, so it’s best to get a loan for only essential purposes. If you need to get one, it’s important to have a clear plan to pay it back.
Explore some situations where a personal loan can benefit you the most, and their drawbacks.
You can use a personal loan for any purpose, including consolidating high interest credit cards to a lower interest rate and home improvements.
Personal loans are unsecured, meaning you do not need collateral to get them.
Before getting a personal loan, it’s smart to consider factors like repayment period, interest rate, the amount you need to borrow and any fees involved.
Paying Off Debts
One of the most common reasons people take out personal loans is to pay off debts, particularly credit card debt. Credit cards tend to have higher interest than personal loans, averaging 14.56% in the first quarter of 2022. This is much higher than the 9.41% average interest rate of personal loans. Keep in mind that using a personal loan to repay credit card debt will only make sense if the loan interest is lower than your credit card rates.
Getting a personal loan to pay off debt can be a practical debt repayment strategy if you qualify for a low interest rate. Through refinancing or consolidation, you can roll multiple credit card payments into one at a lower interest rate, which ultimately helps you pay off debt faster.
You can also use a personal loan to pay off other types of loans, such as payday loans. These often have a higher interest and a shorter term length, so a personal loan can help you lower the costs if you need more time.
A personal loan is not your only option if you need to consolidate credit card debt. Balance transfer cards also allow you to transfer your balance to a new card with a lower interest rate. Some issuers may even waive the interest rate for a few months as a promotion, which can help you pay off your balance without growing interest.
Improving Credit Score
Taking out a personal loan can help improve your credit score. On-time payments and repaid balances at the end of the term can go a long way toward helping you increase your score, as doing so demonstrates that you are a responsible borrower.
Your credit score is affected by the types of credit you get. Paying off a credit card and a loan simultaneously tells lenders that you are responsible enough to manage two lines of credit. With a loan and a credit card bill, you are likely to have a higher score than someone who is just paying off a credit card.
Getting a personal loan with bad credit can help you improve your score. If you have a lot of credit card debt on your report, a personal loan can add a new type of credit to the mix. This can temporarily lower your credit score, but your score will eventually increase with enough on-time payments on both credit types. However, you should approach this strategy with caution. Getting a personal loan with bad credit can be risky, as it can make your credit standing worse if you don’t pay it off on time.
If you struggle to pay off your other debts, getting a personal loan solely to improve your credit score is not the best idea. For instance, if you have a high credit utilization ratio on your credit card, which is how much of your credit limit you’ve used, your score may dip. Focus on reducing your balance first, then open a new line of credit when you are more financially prepared.
Making Home Improvements
Home improvements are another common reason people take out personal loans. A personal loan can fund your endeavors, from minor cosmetic repairs and purchasing new appliances to renovating a part of the house entirely. Personal loans are a less costly credit option than credit cards, given their lower interest rates.
However, since personal loans come with interest, you may pay more than your home improvement project costs. On the flip side, if your home improvement project raises the value of your home to something higher than the cost of your overall loan, then you will have benefited even more. For instance, new roofing can cost you an average of $7,600 but can increase the resale value by $8,000.
If you already have equity built on your home, a home equity loan may be an option for you. This type of loan lets you borrow money against the value of your home and use it as collateral. While this can be a quick option, there is a risk of foreclosure if you fail to pay.
Funding for Education
Personal loans should not be the first or only option when trying to get funds for education. Instead, grants, scholarships and federal loans are better options due to their low interest and flexibility.
Generally, you should take out a personal loan for education purposes only after other funding from federal loans, grants and scholarships is exhausted. You can use a personal loan for special courses that do not qualify for federal student loans. For instance, if you want to upgrade your skills to advance your career, a personal loan may help you achieve your goals.
However, before taking out a loan for career advancement or education, it’s important to calculate its return on investment (ROI). Consider the potential upsides of taking that specific course — will it increase your salary or lead to a promotion? If not, a personal loan may not be worth it.
Personal loans can be used to pay off student loan debts. However, this is generally not beneficial unless your personal loan interest is lower than your federal student loans, which is rarely the case.
Meeting an Emergency
Emergencies can crop up at any time — and you may not always have the cash to cover them. 35% of Americans would be unable to pay for a $400 emergency, much less unexpected healthcare costs, which can rack up quickly. An emergency department visit costs an average of $530 across all age groups. In an emergency, a personal loan can help. However, how soon you can get the funds will depend on your lender's approval process, which is worth considering.
Emergency preparedness can come in many forms, and may help you avoid needing a personal loan. For instance, you can purchase insurance and build an emergency fund. This way, you can recover quickly and efficiently from an emergency without worrying about paying off a loan and interest.
Dealing with emergency medical costs doesn’t always have to mean taking out a loan. You can negotiate with your healthcare provider before receiving treatment or ask about any financial assistance policies they have. Some hospitals may also offer you an interest-free repayment plan. Ask your provider about their options to ensure that a costly loan is your last resort.
Adjusting to a Life-Altering Event
Major life changes, such as getting married or divorced, moving out or switching careers, usually entail costs. Making these moves can be stunted by a lack of funds, which is where personal loans can help propel you forward.
For instance, financially planning for a divorce is essential. An acrimonious divorce can cost more than $20,000 in legal fees, professional consultants and court costs, which is where you may fall short. To avoid ending up worse off financially, you may consider taking out a personal loan to cover the costs of divorce. A loan can also help set you up in a place away from your former spouse, which is vital if the divorce is not amicable.
By preparing for life-changing events financially, you can make the best decisions for your mental, emotional and physical health.
Before taking out a personal loan to fund life-changing events, it’s essential to evaluate how they can impact your life. If you aren’t sure about your decision, you may end up with a lifetime of debt and financial pressure. For instance, borrowing thousands of dollars for a wedding may not be the best choice — especially if you plan on building a family and retiring comfortably.
Factors to Consider Before Getting a Personal Loan
A personal loan is a big financial undertaking that can have repercussions on your long-term financial standing. Before getting a personal loan, consider the factors below to ensure you are prepared for future payments.
- Your Eligibility: Ask yourself if you qualify for a personal loan. Eligibility can vary from lender to lender, but some common factors to consider are your credit score, income and debt-to-income (DTI) ratio.
- The Amount You Can Afford To Pay: If you have good credit, you may qualify for a loan with a high amount. However, it isn’t wise to get the maximum amount if you aren’t sure you can pay it back. Consider how much you need and only get a little extra to cushion yourself against unexpected costs.
- The Repayment Terms: The repayment terms consist of the loan term. Your monthly loan payments will be lower if you have a more extended repayment period, but you'll also pay more interest. Interest rates may also be affected by your repayment period. Generally, shorter repayment periods lead to lower interest rates.
- The Interest Rate: The interest rate should be a major factor when selecting a lender, as interest is a good chunk of what you will be repaying every month. Make sure to consider how well you can comfortably repay the loan without penalties.
- The Fees Involved: Fees can quickly rack up, especially due to late payments. These costs can include application fees, origination fees, late fees and even early repayment fees.
Should You Get a Personal Loan?
- You have a good to excellent credit score
- You need money fast to deal with substantial expenses
- You have debt that you need to pay off to avoid high interests
- You have a plan for repayment
- You can’t afford to make monthly payments on top of other financial obligations
- You need money but not on a time-sensitive matter
- You don’t have solid control of how you spend money
Frequently Asked Questions About Personal Loans
Learn more about when to use personal loans through the most commonly asked questions below.
- Federal Reserve. "Consumer Credit - G.19." Accessed June 14, 2022.
- Federal Reserve. "Economic Well-Being of U.S. Households in 2020 - May 2021." Accessed June 15, 2022.
- Healthcare Cost and Utilization Project. "Costs of Emergency Department Visits in the United States, 2017." Accessed June 15, 2022.
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
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