There are both pros and cons of personal loans, but the pros can easily outweigh the cons in the right situation. Some of the biggest benefits of personal loans are that they can help build credit, they allow consumers to pay off big expenses over time, and they can be used for anything. Major drawbacks of personal loans include interest charges and fees, along with potential credit score damage if things don’t go as planned.
It’s important to weigh the advantages and disadvantages of personal loans before deciding whether or not to apply for one. We’ll help you do just that below.
Top 5 Pros and Cons of Personal Loans:
Ability to pay over time
Ability to consolidate debt
Short-term credit damage (like any loan)
Collateral sometimes required
Can be used for almost anything
Ability to rack up unnecessary debt
Pros of Personal Loans:
Credit building: You will have to make monthly payments, and your lender will report your payment history to the credit bureaus. If you pay on time every month, you can expect your credit score to increase.
High versatility: You can use a personal loan for almost anything you want. Some of the most common reasons for getting personal loans include home improvement, rent, electricity bills, medical expenses, funding a small business, and travel.
Ability to pay over time: A personal loan will allow you to spend a lump sum of money and then pay it back over the course 12-60 months, typically. So your financial burden in any one month will be relatively small compared to the total. In addition, you know what your payment will be each month, which allows you to plan ahead.
Ability to consolidate debt: If you have multiple debts with high interest rates, you may be able to take out a personal loan with a lower interest rate and use the loan to pay off the existing debts. That leaves you with only one monthly payment and less interest accumulation.
Quick decisions: It typically takes 7 business days or fewer to get a personal loan. You may even be able to get approved and receive your funds the same day in some cases. Applying online gets you the fastest decisions.
No collateral: Most personal loans are unsecured, meaning they don’t require any collateral. If you can’t pay the loan back, the lender can’t immediately take your possessions. They’ll have to send your debt to collections or take you to court.
Cons of Personal Loans:
Ability to rack up unnecessary debt. Since personal loans don’t really limit what you can do with the money, it’s possible to go into debt for something you don’t really need. In addition, you could end up borrowing more than you can afford, though lenders try to prevent that by looking at your existing debts and expenses.
Short-term credit damage: Applying for a personal loan results in a hard inquiry on your credit report. This will cause a small, temporary drop in your credit score. In addition, the extra money you owe will raise your debt load, which will also impact your score and make it riskier for lenders to give you additional loans. But as long as you use the loan and other credit responsibly, you should bounce back quickly.
Interest charges: The ability to pay off a balance over a period of months comes with the downside that you have to pay interest. Depending on your credit and the lender, your APR could be anywhere from around 6% to 36%.
Origination fee: Personal loans may charge an origination fee, to cover the cost of processing your application. You might have to pay it upfront. Or it might get added to the total amount of your loan, or deducted from the amount you initially receive. It takes a credit score of 660 or higher to get a loan without this fee.
Other fees: Personal loan providers often charge late fees if you don't pay the monthly bills on time. Some also charge a prepayment penalty for paying off your loan early. This lets them make back some of the money they didn’t earn in interest. But prepayment penalties are rare, and none of the top 15 lenders charge them.
Collateral on secured loans: People with credit scores of 585 or above can usually qualify for unsecured personal loans, which do not require any collateral. But people with scores below that may have to get a secured personal loan, which requires the borrower to offer something valuable as collateral to open the loan. The lender can keep the collateral if you default.
All in all, personal loans are useful for a large variety of purposes, and they allow you to pay off big expenses over time. But they also have the potential to be very costly. Before taking one out, make sure to compare personal loan rates on WalletHub.
You should get a personal loan if you really need to borrow the money and the loan has better terms than other borrowing methods available to you. For example, in certain situations, a credit card or home equity loan might be a better choice. In addition, you should only get a personal loan if you are confident that you can pay the loan off on schedule. Borrowers have defaulted on 3% - 4% of personal loans since 2016, down from 4.8% a decade prior, according to TransUnion. Defaulting on a loan results in significant credit-score damage.… read full answer
If you’re on the fence about whether you should get a personal loan, you can follow this simple checklist. You’ll need to check off all the items for a loan to be worthwhile.
When you should get a personal loan:
The expense is necessary. You can get a personal loan for almost any purpose. But it’s wiser to use a loan for important things like consolidating debt or making home improvements that will increase the value of your property.
Credit cards aren’t a better option. People with good or excellent credit will likely find better long-term interest rates on personal loans than on credit cards. But there are plenty of credit cards with introductory 0% rates for 12-18 months on purchases. So 0% APR credit cards may be the better choice for smaller expenses.
Home equity loans/lines of credit aren’t a better option. You can probably expect to get lower interest rates on a home equity loan or home equity line of credit than with a personal loan, and you may be able to borrow more than you could with a personal loan. But home equity loans and HELOCs use your house as collateral, whereas most personal loans require no collateral. Think over your options in detail before choosing.
You’re confident you can pay it off. Personal loans can last anywhere from 12 to 84 months, though 60 months is a more typical cap. You’ll make payments in equal monthly installments. Before agreeing to a personal loan, look at the monthly payment and put it in the context of all your other monthly expenses. You should be able to comfortably afford the loan payment, and not have to worry about being late.
You can qualify. To get an unsecured personal loan (a loan that doesn’t require collateral) you’ll need a credit score of at least 585. And you probably won’t be able to get a loan without an origination fee unless your score is at least 660.
There are many situations when you should get a personal loan instead of borrowing another way. But there are also plenty of cases where you should not get a personal loan or even borrow at all. For example, taking out a personal loan to go on vacation or to throw a wedding isn’t ideal. It’ll take months or years to pay off the debt from something that only lasted a day or week. In addition, you’ll want to avoid personal loans when you can get a better deal through other borrowing methods.
There are several other cases when you should not use a personal loan either. For example, it’s not a good idea to borrow money to make investments you’re not confident will pay off in the future. And your chances of getting an unsecured personal loan aren’t great when your credit score is below 585. Personal loans are also not ideal in emergencies when you need immediate cash, because the lenders usually take at least a few business days to approve you and deliver the money. You might consider using a credit card or borrowing from family in an emergency instead.
Bottom line: Make sure to compare all options thoroughly before you commit to one.
Personal loans affect your credit score in the short-term and in the long-term. In the short-term, a personal loan may damage your score because it causes a hard credit inquiry and increases your debt load. But in the long-term, a personal loan can either help or hurt your credit, depending largely on whether or not you pay the bills on time. Ultimately, it’s up to you how much impact the personal loan will have.… read full answer
How a Personal Loan Affects Your Credit Score:
Does temporary damage with an initial hard inquiry. When you first apply for a personal loan, your credit score will immediately take a small hit. That’s because applying for a personal loan triggers a hard inquiry into your credit history. But this shouldn’t drop your score by more than 5 points or so, and you should be able to bounce back quickly.
Adds to your overall debt. If you’re approved for a personal loan, you will immediately have a higher debt load, which may cause your credit score to drop in the short-term. That’s because the more debt you have, the riskier it is for banks and credit unions to lend to you.
Reports to the major credit bureaus monthly. The banks, credit unions and online lenders that issue personal loans report payment information to the major credit bureaus on a monthly basis. If you make on-time payments, you can expect your score to increase. But if you are late or don’t pay altogether, your score will drop.
Improves your credit mix. Proving yourself capable of managing multiple types of loans and lines of credit responsibly is good for your credit score. It shows you can be trusted to repay what you borrow in a variety of situations. So if you only have one or two other types of accounts on your credit report, such as credit cards or student loans, your score may benefit in the long run from getting the personal loan.
Could help reduce credit utilization. Personal loans give you a lump sum up front, which you pay back in monthly installments. This is different from a credit card, where you can borrow up to a certain amount any time you want. Credit cards are known as “revolving credit,” and a big part of your credit score is how much of your revolving credit you use up each month, or your “credit utilization ratio.” Personal loans don’t count toward this ratio, so if you use them to pay off revolving debt, you can lower your ratio and improve your score.
In conclusion, as long as you’re sure to pay on time each month, a personal loan should eventually increase your score by a lot more than the initial inquiry caused it to fall. You can also avoid wasting hard inquiries by getting pre-qualified for a loan first. Pre-qualification only uses a harmless soft inquiry. And while it doesn’t guarantee approval, it will let you know if your odds are good.
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