Personal Loans

Are Personal Loans a Bad Idea? And 2 Other Key Questions We Answer Here

Woman budgeting at home

A personal loan is a type of unsecured loan that can be used to pay for virtually anything. There are a lot of misconceptions about personal loans, so it makes sense to ask questions before you consider pursuing this type of financing. Keep reading to learn more about personal loans and see if this financing option might be right for your financial situation.

Are personal loans bad? Not necessarily
When taking out a personal loan can be a good idea
When you shouldn’t take out a personal loan
How do I take out a personal loan?
What are the alternatives to taking out a personal loan?

Are personal loans bad? Not necessarily

Personal loans are not inherently bad. Like any other financing tool, personal loans can be used well or poorly. Just like you wouldn’t want to rack up credit card debt on unnecessary purchases, you wouldn’t want to take out a personal loan to pay for things you don’t need (or can’t afford).

As a whole, consumers often use personal loans as a debt consolidation or refinancing tool to help them save money in the long run and pay off debt faster. The vast majority of people who searched for a personal loan on LendingTree in Feb. 2020 wanted to consolidate debt (35.9%) or refinance their credit card debt (31.3%) for better terms.

So when asking yourself, “Are personal loans a bad thing?” remember that it can be a beneficial option for people who use it as intended.

When taking out a personal loan can be a good idea

You want to pay off credit card debt faster

If you’re struggling with uncontrollable credit card debt, a personal loan can be a life preserver. You can often refinance for a better APR and faster debt payoff with the fixed monthly payments offered by a personal loan.

You’re having trouble juggling all your bills

It’s easy to miss a payment when you have a ton of bills to keep track of. A personal loan can consolidate all your debts into one fixed monthly payment, so you’ll never pay a late fee after forgetting to pay a bill.

You have a prime credit score and can qualify for a reasonable APR

Borrowers with a strong credit history and strong finances will likely see their best terms on a personal loan, such as lower APRs and higher loan amounts. So if you need to finance a major purchase and you have an excellent credit profile, a personal loan may be a viable option, especially when compared with a credit card.

You want to renovate your home to boost its resale value

If you don’t have the cash to pay for renovations upfront, you can take out a home equity loan or a personal loan. Nearly 6% of LendingTree personal loan inquiries were for home improvements in Feb. 2020.

When you shouldn’t take out a personal loan

You can get better terms with an alternative financing option

When making decisions about your finances, it’s best to compare your options. In most cases, a personal loan won’t be your only option. Weigh the pros and cons of personal loans versus credit cards, payment plans and other alternatives.

You’re taking out unnecessary debt

As a rule, you shouldn’t take out debt to finance an unnecessary expense. While personal loans can be a good debt consolidation tool, it’s generally not a good idea to take out debt to pay for a vacation, for instance.

You won’t qualify for a loan with a reasonable APR

Borrowers with subprime credit may only qualify for a personal loan with a high APR, if they qualify at all. In some cases, it’s best to work on improving your credit (such as with a secured credit card) before applying for a personal loan.

You aren’t confident in your ability to repay the loan

You should only borrow money that you are confident that you can pay back. If you don’t pay your personal loan, you could ruin your credit score, making it hard to secure good financing terms in the future.

How do I take out a personal loan?

  1. Check your credit score and history. This will give you a good idea of where you stand and if you’ll qualify for good terms on a personal loan. You can see your credit score through a variety of free services, including My LendingTree. To see each of your credit reports from the three major credit reporting bureaus, visit AnnualCreditReport.com. You can do this for free every 12 months. Once you have your reports, check them for errors and dispute credit report errors.
  2. Decide how much you need to borrow. If you borrow too little, you might not have the money needed to refinance your credit cards or make a big purchase as planned. If you borrow too much, you could be stuck paying interest on money you didn’t really need to borrow.
  3. Get prequalified for a personal loan. This gives you an estimated APR without a hard pull of your credit, so you can shop around for your best deal before committing to a lender. You can compare offers from up to five lenders using LendingTree.
  4. Compare offers and choose your best one. When you’ve chosen a lender, you can then submit a formal application through them. You’ll have to show proof of income (like a paystub), and they’ll conduct a hard credit inquiry. If approved, you can generally expect to get funds within a few business days.

Factors to consider when choosing a personal loan lender

APR

Generally, the lender with the lowest offered APR may be your best choice, because a lower APR means that you’ll spend less over the life of the loan. The less the loan costs, the more money you can use to pay down debt or put in savings every month.

Fees

Consider things like loan origination fees and prepayment penalties. A loan origination fee is assessed when you take out the loan and can be 1% to 8% of the cost of the loan. A prepayment penalty is assessed when you pay off your loan before the end of the term. Keep in mind that not all lenders charge these fees.

Reviews

If you’re having a hard time choosing between a few lenders, search for personal loan lender reviews. You might learn that a lender has excellent customer service or fast funding by reading reviews.

What are some alternatives to taking out a personal loan?

Credit cards

Personal loans and credit cards are both generally unsecured forms of lending, but credit cards give you the flexibility to spend — and pay interest on — how much you want to spend each month. On the other hand, personal loans have fixed monthly payments, so you’ll always know what you owe.

Credit cards tend to have higher APRs than personal loans for good-credit borrowers. If you have prime credit and want to open a credit card for a major purchase, then you may qualify for 0% APR promotional financing that typically lasts from six to 18 months. Note, though, that you’ll be on the hook for deferred interest if you don’t pay off the balance by the time the promotional period ends.

Secured loans

Secured loans come in many forms. You could open a secured personal loan, a type of personal loan that uses an asset, such as your car or savings account, as collateral. In the event that you don’t pay back the loan, the lender can seize the collateral to make up for any money that was lost.

You have to face an added risk of losing an asset, but if you feel confident in your ability to pay back the loan, then you may qualify for a lower APR with a secured loan than an unsecured loan. Secured loans may be viable options for borrowers with little to no credit.

A home equity loan is another example of a secured loan. This type of loan lets you borrow against the value of your home as collateral. Home equity loans tend to have longer terms and lower APRs than unsecured personal loans.

Payment plans

If you’re thinking of taking out a personal loan to finance a big purchase from a retailer, see if the retailer itself offers payment plans. Some shops, like Amazon and Best Buy, offer deferred-interest financing through their store-branded cards. This means you could potentially pay no interest at all if you make your payments on time. But if you don’t make your payments, you could be on the hook for back-interest charged from the date of purchase.

Negotiating your debt

If you’re struggling to pay medical debt, it may be tempting to turn to a personal loan for fast, simple funding. But it’s worth the effort to talk to your healthcare provider about setting up a payment plan or negotiating the balance down first if you can’t pay the bill.

 

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