Are Personal Loans a Bad Idea? (And Other Key Questions)
Borrowing a personal loan isn’t a bad idea if you qualify for a low rate and reasonable repayment terms. But if you get stuck with high-interest debt you can’t afford, a personal loan probably wouldn’t be a good fit for your situation.
Before you apply, it’s important to learn how personal loans work, as well as their pros and cons. If you decide a personal loan is bad for your current circumstances, you might consider alternative financing options that could be a better match.
To learn more, let’s answer the following:
What is a personal loan?
Personal loans are installment loans that you pay back over time, usually between three and seven years. You can use a personal loan for a variety of expenses, from financing a home improvement project to consolidating debt.
Many banks, credit unions and online lenders offer personal loans. Interest rates have a wide range, but some states cap them at 36%. If you encounter a higher interest rate, you might be dealing with a payday lender that’s charging predatory interest charges and fees.
Lenders look at your credit and income to determine whether you qualify for a personal loan. Borrowers with the best credit scores will get the lowest rates.
You can often check your rates online with no impact on your credit score. This process is called prequalification and only takes a couple of minutes.
If you choose to borrow a personal loan, you will receive all your funds upfront. You will start making monthly payments right away on the agreed-upon repayment schedule.
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 June 2021 wanted to consolidate debt (30%) or refinance their credit card debt (18%) 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.
|A personal loan can be a good idea when…||A personal loan can be a bad idea when…|
|You want to pay off credit card debt faster||You can qualify for better terms with an alternative financing option|
|You’re having trouble juggling all your bills||You’re taking out unnecessary debt|
|You have a prime credit score and can qualify for a reasonable APR||You won’t qualify for a loan with a reasonable APR|
|You want to renovate your home to boost its resale value||You aren’t confident in your ability to repay the loan|
WHEN IS TAKING OUT A PERSONAL LOAN 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 the 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. More than 8% of LendingTree personal loan inquiries were for home improvements in June 2021.
WHEN SHOULD YOU AVOID TAKING 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.
What are some pros and cons of personal loans?
Personal loans have both advantages and disadvantages. It’s useful to be aware of these pros and cons before you borrow.
You can use a personal loan for almost anything. Personal loans are flexible and versatile; you can use a personal loan to finance anything from a home renovation project to a major purchase to debt consolidation.
It’s possible to get an affordable interest rate. If you have a strong credit score, you might qualify for an affordable, single-digit interest rate.
You can spread out your payments over several years. If you want the lowest monthly payment, you can choose a long term to pay off your debt. Most lenders offer a maximum term of seven years.
Borrowing limits might be higher than other options. Some lenders let you borrow up to $100,000, a much higher sum than you could put on most credit cards.
You don’t need to put up collateral. Many personal loans are unsecured, so you don’t need to risk your car, house or another asset to borrow one.
You can consolidate your debt to make it more manageable. If you owe various sums to different lenders, consolidating your debt with a personal loan can streamline repayment.
You could be taking on unnecessary debt. The versatility of personal loans can have a downside; you might borrow money for a nonessential purpose. For example, if you’re borrowing a loan to pay for a vacation or wedding, you might come to regret taking on that debt.
You might find a lower interest rate elsewhere. If you can’t score a low rate, you might be better off using a credit card, home equity loan or home equity line of credit.
You could get charged extra fees. Some personal loans come with origination fees, prepayment penalties or other fees that can drive up your costs.
Your monthly payments might be high. A personal loan is a fixed installment loan, so you need to pay a certain amount every month to meet your repayment deadline. You might prefer a credit card, which has no set deadline for paying off your full balance (but note that interest charges will continue to accrue).
How do I take out a personal loan?
- 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 LendingTree’s app. To see each of your credit reports from the three major credit reporting bureaus, visit AnnualCreditReport.com. Once you have your reports, check them for errors and dispute credit report errors.
- 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.
- 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 multiple lenders using LendingTree.
- 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
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.
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.
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?
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 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.
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 health care provider about setting up a payment plan or negotiating the balance down first if you can’t pay the bill.