Top 6 Reasons to Get a Personal Loan

Personal loans offer the freedom to cover various expenses, from consolidating debt to financing large purchases. This flexibility, combined with typically lower interest rates than credit cards, makes them an appealing option for many.

However, the ease of accessing personal loans can lead to their misuse. Borrowing money for unnecessary expenses can result in financial strain and debt accumulation, so it’s wise to understand the right circumstances for taking out a personal loan. By borrowing responsibly, you can ensure that personal loans remain a beneficial tool rather than a financial burden.

Debt consolidation is one of the most common strategic reasons for obtaining a personal loan. Many individuals find themselves managing multiple debts, each with its own interest rate and monthly due date. This can not only be financially draining but also challenging to keep track of.

A personal loan can simplify this complexity by combining various debts into a single loan. This consolidation often results in a lower overall interest rate compared to the combined rates of the original debts, leading to potential savings on interest payments.

Moreover, consolidating debts with a personal loan transforms multiple monthly payments into one predictable payment. This streamlining makes budgeting more manageable, reducing the likelihood of missed payments that could negatively impact credit scores. Plus, most personal loans have a fixed repayment term, providing a clear timeline for debt freedom, unlike revolving credit lines, which can prolong indebtedness.

A personal loan can be a strategic tool for improving your credit score. Payment history is a significant component of credit scoring models and accounts for 35% of a FICO Score calculation. By obtaining a personal loan and diligently paying it back on schedule, you demonstrate financial responsibility and reliability to credit bureaus, which can lead to an improved credit score over time.

In addition to timely payments, diversifying your credit mix can also benefit your credit score. Credit mix refers to the variety of credit types you manage, such as credit cards, mortgages and loans. Adding a personal loan to your credit portfolio introduces a different kind of credit, particularly if your existing credit is primarily from credit cards. Credit scoring models favor this approach as it indicates your ability to handle various types of credit responsibly.

A personal loan can be an effective financial solution for funding home improvements, whether they are minor updates or major renovations. This is because personal loans often provide quick access to a lump sum of cash. This is particularly beneficial for home improvement projects, where costs can be significant and upfront payment is often required.

Personal loans also often come with more affordable terms than credit cards, particularly in terms of interest rates. While credit cards can offer the convenience of incremental payments, their higher interest rates can significantly inflate the total cost of a home improvement project over time.

In contrast, personal loans typically offer lower interest rates, leading to more manageable and cost-effective financing. This can be especially advantageous for more expensive home renovations, where the difference in interest can amount to substantial savings.

Personal loans stand out for their flexibility, allowing borrowers to use the funds for a variety of purposes, including making large purchases. Unlike auto loans or mortgages, which are restricted to specific purchases, personal loans offer the freedom to buy a range of items, from high-end appliances to expensive electronics.

Because personal loans are often unsecured, collateral like a house or car is unnecessary. This is particularly beneficial for borrowers who might not have significant assets to offer as security or prefer not to risk their assets. The absence of collateral simplifies the loan process, making it more straightforward and accessible.

Additionally, the borrowing limits for personal loans can be relatively generous based on your credit score and financial history. Those with good credit scores often have access to higher loan amounts, providing the necessary funds for substantial purchases. This high borrowing limit and the lack of collateral make personal loans an attractive option for financing significant purchases.

Personal loans can be a lifeline for covering unexpected expenses, providing a quick and accessible financial solution during emergencies. Many lenders offer online applications, which simplifies the process and saves time. This ease of access means you can apply from anywhere without needing to visit a bank or financial institution in person.

Additionally, personal loans often provide fast funding. Once approved, the funds can be deposited into your account relatively quickly, sometimes within a few days. This swift turnaround is crucial in emergencies, where immediate access to funds can make a significant difference. Whether for medical bills or urgent car repairs, a personal loan can provide the necessary financial support.

Personal loans can offer essential financial support during major life changes, helping individuals navigate transitional periods. These loans provide a lump sum of money that you can use to cover various expenses associated with significant life events. Additionally, their flexibility allows borrowers to allocate funds according to their specific needs without the constraints of more specialized loans.

For instance, going through a divorce often entails numerous unforeseen expenses, ranging from legal fees to establishing a new residence. A personal loan can provide a sum of money you can use flexibly to meet these varied expenses. This can be particularly helpful in a time when financial resources might be stretched thin or divided.

A personal loan is a significant financial commitment that can impact long-term financial health if not managed wisely. Assessing your circumstances and loan terms ensures you get the whole picture before you decide.

• Loan Eligibility: Factors like credit score, income and debt-to-income ratio determine your eligibility for personal loans. Lenders generally prefer a debt-to-income ratio (DTI) of 36% or less for personal loans. This ratio represents the total amount of your existing monthly debts divided by your pre-tax monthly income. Some lenders may allow higher DTIs. A strong credit profile increases your chances of approval and potentially better loan terms. Understanding your eligibility helps set realistic expectations and prevents applying for loans you're unlikely to get, which can negatively affect your credit score.

• Amount You Can Afford to Pay: Assess your financial situation to determine how much you can realistically borrow and repay. Overestimating your repayment capacity can lead to financial strain and missed payments, adversely affecting your credit score and future borrowing capability.

• Repayment Terms: The loan's repayment terms, including the duration and frequency of payments, significantly influence your financial planning. Extended repayment periods might lower monthly payments but increase the total interest paid. Choose terms that align with your financial stability and budgeting goals to avoid future financial stress.

• Interest Rate: The interest rate directly affects the total cost of the loan. Lower rates mean less interest over the loan's life, making repayments more manageable. Compare interest rates from different lenders to ensure you're getting a competitive rate, keeping in mind that rates vary based on your creditworthiness and other factors.

• Additional Fees: Be aware of extra fees, such as origination fees, prepayment penalties or late fees. These can add up and significantly increase the cost of the loan. Understanding all associated costs helps you accurately compare loan options and plan your finances effectively.

Considering these different factors before applying will help you make an informed and responsible decision.

While personal loans offer versatility and can be beneficial in many situations, they may not be suitable for every financial need. Below, we explore some circumstances where there may be better paths forward than a personal loan.

• You Have Bad Credit: Getting a personal loan with bad credit might be challenging and expensive. Bad credit often leads to higher interest rates or outright loan rejection, as lenders view you as a higher risk.

• You Can't Afford the Monthly Payments: Assess your budget before taking a loan. If the monthly payments stretch your financial capabilities too thin, you risk defaulting on the loan. Defaulting can lead to severe consequences like damaged credit scores and legal actions, making future financial transactions more difficult.

• You Don't Have a Specific Use for the Funds: Only take a personal loan with a clear purpose. Using loaned funds for unnecessary expenses can lead to irresponsible spending and excessive debt. Having a specific, sensible use for the loan helps ensure it benefits your financial situation rather than hinders it.

• You Have Too Many Debts: If you're already struggling with multiple debts, adding another loan can worsen your financial situation. In this case, a personal loan can increase your debt burden, making it harder to manage payments and potentially leading to a debt spiral.

Recognizing the scenarios where a personal loan could be more harmful than helpful will assist you in avoiding making a decision that negatively impacts your financial health.

Sometimes, different financial products may better match your specific needs than a personal loan. We highlight some of the popular alternatives below:

• Credit Cards: Credit cards can be more flexible for shorter-term borrowing needs or minor expenses. Many credit cards offer rewards and interest-free periods, making them ideal for everyday purchases or minor emergencies. However, they usually have higher interest rates post-introductory period, so they're best for expenses you can pay off quickly.

• Home Equity Loans: If you own a home and have built up equity, a home equity loan can be a cost-effective way to borrow a large sum. These loans typically have lower interest rates than personal loans and offer a lump sum with fixed repayment terms. However, they use your home as collateral, which can be risky if you're unable to make payments.

• Home Equity Line of Credit: A home equity line of credit (HELOC) works like a credit card but uses your home's equity as collateral. It offers flexibility in borrowing and repaying, making it suitable for ongoing expenses like home renovations. The interest rates are generally lower than personal loans, but the risk of using your home as collateral remains.

• 401(k) Loans: Borrowing from your 401(k) can be an option if you need funds without a credit check. These loans don't impact your credit score and have relatively low interest rates. However, they reduce your retirement savings, which can have tax implications and penalties if not repaid. Note that not all 401(k) plans allow loans.

• Personal Lines of Credit: Similar to a credit card, a personal line of credit offers flexible access to funds up to a certain limit. This option is ideal for ongoing expenses or if you're unsure of the exact amount you'll need. They often have lower interest rates than credit cards but higher than personal loans, making them a middle-ground option for various financing needs.

Exploring the available alternatives allows you to choose the most suitable option for your financial situation and goals.

MoneyGeek compiled a list of frequently asked questions to provide valuable insight about when to get a personal loan and help you make financially sound decisions.