Personal Loans

Should I Get a Personal Loan?

So you need cash, and fast. If you don’t have other assets to borrow against — or even if you do — you may be considering a personal loan. Unsecured personal loans are flexible and can be useful in some situations, but they also come with limitations. Here’s what you need to know before you borrow.

What are personal loans?

Good reasons to take out a personal loan

5 questions to ask first

How to find a good personal loan

The bottom line

What are personal loans?

A personal loan is a type of unsecured loan, which means that you don’t have to put up any collateral like your car or home when you borrow. The loan is simply guaranteed by your promise to repay what you owe.

A key benefit of a personal loan is that there are few restrictions on how you use the money. Personal loans typically range from $1,000 to $35,000 for terms between two and five years — though some lenders may offer higher amounts or longer terms.

But because you are not required to put up any property or assets as collateral, lenders take a bigger risk when they lend you money. This means that interest rates are often higher and credit requirements are stricter than you might see with secured loans. While it’s possible to get a personal loan with fair credit, you’ll get the most competitive rates with an excellent credit score.

In addition to flexibility, personal loans typically have fixed interest rates and predictable payments, and they’re good if you need money quickly because the application process is simpler than for other types of loans. They also can help boost your credit if you make your payments on time — and if the loan diversifies your credit portfolio — but you’ll pay interest in exchange for this benefit.

Good reasons to take out a personal loan

You can use a personal loan to pay for almost anything — but that doesn’t mean that it’s always the right choice. Here are a few reasons to consider a personal loan:

You have high-interest credit card debt

If you have outstanding debt on a credit card with a high interest rate — or if you have multiple account balances you’re trying to pay off — a personal loan is one option to consolidate your debt. With this strategy, you take out a personal loan and use the money to pay off your higher-interest debt. Then, you make a single monthly loan payment each month, ideally at a lower interest rate than what you’re currently paying.

According to recent data from the Federal Reserve, the average credit card interest rate in May 2018 was 14.4% — compare that with an average of 10.31% on a 24-month personal loan.

A personal loan used for debt consolidation can help people better manage their budgets because it makes monthly payments more predictable.

“The primary benefit is it converts debt with a fluctuating interest rate to one with a fixed rate so you are put on a path to paying off the debt,” Carl Holubowich, a CFP and principal at Armstrong Fleming & Moore in Washington, D.C., told LendingTree.

In addition to streamlining your monthly bill payments, personal loans have other advantages, especially compared with other debt consolidation methods:

    • Personal loans don’t come with balance transfer fees like some credit cards, though some lenders may charge an origination fee.
    • Diversifying your credit lines, increasing how much credit you have available and making on-time loan payments can help raise your credit score.
    • Loan repayment terms generally range from 24 to 60 months, so you can find a monthly payment that fits in your budget.

While debt consolidation might be one of the most practical (and common) uses for a personal loan, research all of your options before you commit. You have to pay interest on your entire loan balance, and depending on the terms, this could cost you a lot over time.

Your home needs repairs or upgrades

If your roof needs to be replaced ahead of storm season or your HVAC system dies at the height of summer, you probably need to take immediate action to get those things fixed. A personal loan can help cover large home improvement expenses, and because it takes just a few days to get your money, it’s a good option for urgent repairs.

That said, a home equity line of credit, or HELOC, might be a better choice for some borrowers. With a HELOC, you only take out and pay interest on the cash that you actually need, and because it’s secured by your property, the interest rate is likely lower than on an unsecured loan.

However, if you don’t have enough equity in your home to qualify for a HELOC — you just purchased the property, for example — a personal loan can help cover those emergency situations.

You have unexpected medical expenses

A personal loan can help you pay back or consolidate medical bills or other emergency expenses. But before you go that route, look into other options for covering your medical debt.

Hospitals and health care providers are often willing to negotiate, reduce or eliminate outstanding balances depending on your situation, so always try other strategies before you take on a loan with interest.

You’re making a major purchase in the near future

You can use a personal loan to pay for your bucket list vacation, your dream wedding, or a new computer — but that doesn’t mean you should. Before you take out a loan for these types of expenses, consider whether it’s worth the debt you’re taking on.

Calculate how much the purchase will cost you in added interest and only go the personal loan route if you already have excellent credit, qualify for a low rate and are able to pay the loan back quickly to minimize that extra cost.

5 questions to ask first

Before you take out a personal loan, there are a few important questions to consider.

Why do I want a personal loan?

A personal loan is a big financial commitment that comes at a cost, and you should take this on responsibly. Debt consolidation to improve your financial situation is a good use of a personal loan — a lavish vacation, perhaps not so much.

What will my monthly payment be?

Your monthly loan payment will depend on how much you borrow, your interest rate and the length of your loan term. Need help doing the math? Put your loan amount, rate and term into LendingTree’s payment calculator to compare monthly payments based on offers you receive.

Once you’ve calculated your monthly payment, make sure it fits within your budget. Don’t take on a personal loan if it will sink you further into debt or compromise your ability to cover your expenses.

How much interest will I pay?

One advantage of a personal loan is that your interest rate is usually fixed, not variable, which means you’ll know upfront exactly how much interest you’ll pay over your loan term. Your credit score is a huge factor when lenders calculate your interest rate.

A LendingTree analysis published in August 2018 found that the average APR offer for borrowers with excellent credit (760 or above) was 8.10%, while those with scores between 640 and 679 saw an average offer of 24.67%.

No matter your APR, you’re still paying interest on what you borrow, so it’s important to decide whether the purchase you make is worth that added cost.

Is my financial situation stable?

Personal loan terms range from 24 to 60 months, so you may be making payments for several years if you aren’t able to pay the balance down more quickly. If you expect your employment situation and income level to change, or if you anticipate other major expenses — your child is going off to college, for example — you may not be in a position to make your loan payments two or three years down the line.

Is my lender trustworthy?

In most cases, borrowers with poor credit have a harder time qualifying for personal loans. Lenders take a risk when they give out loans without securing any collateral, so they’re more likely to work with you if your credit is average to excellent. That leaves room for less-than-reputable lenders to offer seemingly attractive terms to borrowers in dire straits.

“With a commercial lender, is it one of the primary ones you hear about and read about, or is it some fly by night place that’s going to charge far too much?” said Jon L. Ten Haagen, a CFP and founder of Ten Haagen Financial Group in Huntington, N.Y.

“The fees that you’re charged by non-legitimate loan shark kind of people, people say ‘Oh, yeah, I can pay them back, no problem,’” he added. “But when they jack the interest rate up on you without telling you ahead of time, they can be a problem.”

How to find a good personal loan

The most important step to finding the right personal loan is to do your research. This means shopping around with different lenders so you get the lowest rate possible. According to a recent LendingTree analysis, borrowers can save up to 35% — an average of $1,700 on a three-year personal loan — by bargain hunting. Lenders offer a wide range of interest rates to borrowers across credit score categories, so it pays to compare.

When you’re ready to shop, start with your current bank or credit union. An existing relationship may help you secure better rates or overcome a spotty credit history. Then check rates at online-only lenders, or use a loan marketplace like LendingTree’s rate comparison tool to get offers from several lenders at once.

When you’re comparing offers, look at fees and penalties in addition to interest rates. A hefty origination fee may cost you more in the end than a slightly higher rate, but it could also reduce the cash you actually receive upfront. Make sure you understand exactly what you’re getting and everything you’ll owe.

The bottom line

A personal loan should fit into your bigger financial picture. If what you’re purchasing is a burden you can’t actually afford, think carefully about how that debt will impact your long-term fiscal well-being.

 

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