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What Are the Pros and Cons of Personal Loan Options?

What Are the Pros and Cons of Personal Loan Options?
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You might consider personal loans if you need funds fast for a specific purpose. This is because they offer flexible financing options and fund quickly. However, you should first understand the pros and cons of personal loan options to determine if it’s the best choice for you.

What Are Personal Loans?

A personal loan is an installment loan. They usually have fixed interest rates and monthly payments. You can request a personal loan from your local bank, online lenders, or credit unions. Most lenders don’t require you to divulge the reason you need the loan, and they usually fund quickly, helping you get the money you need fast.

Personal Loan Pros and Cons

pros and cons of personal loans

Before applying for a personal loan, learn the pros and cons of personal loans, as there are many.

Of course, every person has different needs and qualifications, but understanding the basic good and bad sides of loans can help you determine if they’re right for you.

Personal Loan Pros

Here are the top personal loan benefits.

One Lump Sum of Funds

You get all your funds at one time when you apply for a personal loan. You can use the funds however you want, and if you don’t use everything at once, you can put the money borrowed in a savings account to grow interest or make larger monthly payments to pay the loan off faster if you don’t need the excess funds.

When you receive a lump sum, you know your total loan payment upfront and don’t have to worry about adjusting your budget.

Funds Fast

Most personal loans are unsecured. This means you don’t have to worry about dealing with collateral like you would with secured loans. To apply, you must prove you can afford the loan with your income and have a good credit report and history. Many lenders can fund personal loans in as little as 24 hours or up to a few days. This is much faster than other loan options.

Avoid Collateral

Unsecured personal loans don’t require collateral or something you put down in case you miss payments. The most common forms of collateral are homes and cars, which no one wants to risk.

While you shouldn’t borrow an unsecured loan unless you know you can afford it, there is peace of mind knowing you don’t risk losing anything important to you if you have financial troubles.

Builds Credit

Your payment history makes up the largest part of your credit scores. So if you make your personal loan payments on time, it can help you build credit. Showing future lenders you can handle loans may also help you get approved for more financing.

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Low Loan Interest Rates

Personal loans may charge lower interest rates than credit cards. It’s common to get an interest rate of 10% or more. This is lower than the rates credit card companies charge.

For example, if you borrow $5,000 with a personal loan at 10% for five years, you’d pay $1,374.11 in interest charges. But if you put $5,000 on a credit card at 20% and paid it off in five years, you’d pay $2,948.17 in interest.

Flexibility and Multiple Uses

Personal loan lenders don’t tell you how you can use the funds. Instead, you receive the lump sum and can do what you want the funds. This differs from auto loans or mortgages, which you can only use to buy a car or house.

Personal loans are a better option if you want to consolidate debt, make home improvements, or have any other use for the funds. You don’t have to disclose what you’ll do with it to the lender.

Terms Are Extended

Personal loans are good for two to ten years with most lenders. This allows you more time to pay off the debt without paying high-interest rates.

To determine the best term for you, look at the monthly payments to determine what you can afford. The shorter the term, the less interest you’ll pay, but you should have a monthly payment that fits into your budget.

Manageability

Having only one loan to manage can make it a lot easier to handle your financial situation. When you can get all your funds in one loan, you don’t have to worry about using multiple credit cards or borrowing money from multiple sources.

Easier Debt Consolidation Later

You may consider debt consolidation with a personal loan if you have many high-interest consumer debts. Having one loan to manage can be a lot easier. You don’t have to juggle multiple payments, risk late payments, or get confused when trying to get out of debt.

Personal Loan Cons

Personal loans also have some downsides you should consider.

Potentially Harsh Affects on Credit

When you apply for a new loan, your credit score initially drops. This is due to your higher debt burden and the lower average credit age the new loan causes.

The initial damage won’t last long; however, your payment history plays an important role. If you miss a payment, such as not making payments for many months, your credit score will drop.

Personal loan lenders report personal loans to the credit bureaus. This includes the amount you borrow if you meet the repayment period and your outstanding loan amount. Missing payments can lead to a decreased credit score and trouble getting loans in the future.

Payments Are Higher Than a Credit Card

Personal loans have higher required payments than credit cards because they have a fixed repayment period. You can carry credit card balances forward for as long as you want (not recommended). This means you can make the minimum payment required and not hurt your credit.

On the other hand, personal loans require principal and interest payments that allow you to repay the loan within the determined term, such as two to ten years. The higher monthly payments can be hard to budget for, making it harder to make ends meet.

More Eligibility Requirements for Borrower

Personal loan lenders have strict qualifying requirements. You must prove you have the required credit score plus the income to cover your existing and potential debt burden. In addition, lenders will require proof of income, employment, and possibly your assets to ensure you can comfortably afford the loan.

It may be harder to qualify if you have bad credit or a high debt-to-income ratio.

High Fees and Penalties to Consider

Personal loans often have fees you pay upfront, such as origination fees. These can be 1% – 6% of the loan amount and come from the cash you receive. For example, if you borrow $5,000 and have a 3% origination fee, you’ll receive $4,850 when the loan disburses.

There may also be prepayment penalties or other fees lenders charge. It’s important to understand the loan’s terms and ask lenders what the total cost of the loan is, so you know what it will cost.

Additional Monthly Budget Payment

A personal loan increases your monthly expenses for two to ten years. It’s important to budget for the payment and ensure it fits. Think long-term or as long as the loan period. For example, if you plan to go down to one income or change jobs soon, this could affect your budget and make it harder to afford the additional monthly payment. You don’t get the option to make a minimum payment, like a credit card; you must make the full payment monthly.

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Increases Debt to Income Ratio

Taking on a new loan means increasing your debt burden. The more debt you have when compared to your income, the higher your debt-to-income ratio gets. Some lenders have maximum DTIs they allow, but even if they don’t, increasing your debt load can be detrimental to your finances.

Interest Rates Could Be Higher Than Alternatives

If you don’t have excellent credit, you may pay higher interest rates than other options allow, such as a secured personal loan or credit card with an introductory APR.

It’s important to compare your options to all available choices for your funding to ensure you aren’t overpaying.

Alternative Options

are personal loans worth it

Personal loans aren’t the only option when you need to borrow money. Here are a few other ways to get money at competitive interest rates.

Home Equity Loan

Home equity loans might be an option if you own a home and have equity. These loans use your home’s equity, or the difference in your home’s value and any outstanding loans, as collateral.

A home equity loan is secured. It uses your house as collateral. You may get better interest rates on this type of loan because it’s secured. Home equity loans usually charge a fixed interest rate and monthly payments like personal loans.

With a home equity loan, the lender provides the funds as one lump sum, like a personal loan. You can also use the funds however you need.

Also, like personal loans, you’ll need good credit, proof of income and employment, and a low enough debt-to-income ratio to qualify for the loan. Plus, you put your home up as collateral. If you can’t make your payments, you put your house at risk.

Home Equity Line of Credit

A home equity line of credit is an additional way to borrow your home’s equity. HELOCs are also a second mortgage on your home, using your home as collateral.

However, HELOCs don’t have fixed interest rates, unlike a home equity loan. Instead, the rate is variable and can change monthly. This makes it harder to budget for the payment because you never know how much it will be.

Also, unlike home equity loans, you receive your funds as a line of credit, similar to a credit card. You can use the funds as needed or leave them untouched. Your monthly payments are based on the amount you withdraw, similar to a credit card. You aren’t required to make principal and interest payments until you’ve had the loan for ten years.

You can use the funds as much as you want during the ‘draw period’ up to your limit. Then, you’ll repay what you borrowed plus interest during the repayment period.

Zero APR Credit Cards

Zero APR credit cards are almost like paying cash. Of course, you’ll need excellent credit to qualify, but you won’t pay interest on the debt for the promotional period if you do.

For example, you don’t pay interest if you have a 0% APR for 12 months. You don’t pay any interest if you pay the balance in full. However, any remaining balance is subject to the current credit card interest rates.

Related Article: Should You Utilize a Personal Loan to Pay Taxes?

Choosing for or Against Taking a Personal Loan

Deciding if personal loan funds are right for you is a personal decision. It’s important to consider the good and bad sides of personal loans and determine if they are right for you.

Look at the monthly payment required, the fees, interest rates, and loan terms. To determine if it’s right for you, consider the following:

  • Do you have excellent credit? The better credit you have, the better the interest rates lenders will offer.

  • Why do you need a personal loan? Do you need to consolidate debt, pay for a large expense, or have another purpose? You shouldn’t borrow a personal loan just because you can; you should have a purpose.

  • Can you control your spending? A personal loan isn’t a good idea if you just want more capital to spend. You’ll pay interest on the entire loan amount upfront, and unless the funds are for something necessary, it’s not a good idea.

  • Can you afford the payments? Consider your budget and how the monthly payment fits into it (or doesn’t.). It’s not worth stressing your budget for a loan you don’t need.

  • Do you need the money immediately? If you have a financial goal that’s not immediate, you might be better off saving for it and saving on the interest costs.

Choosing a Personal Loan Option

If you decide a taking out a personal loan is right for you, here’s what to consider.

Check Rates of Lenders

Every lender charges different interest rates. Use a loan marketplace like LendingTree, or look around individually but see what interest rates lenders offer. You may not get the advertised rate, but at least you can see where they start.

Determine the Amount You Need

Determine how much you must borrow. What is your intended use for the funds? Don’t borrow more than you need, but make sure you borrow enough to cover the goals, such as consolidating debt, home improvements, or paying a large expense.

Compare Multiple Lenders

Get pre-approved from several lenders and compare your options. First, compare the offers, interest rates, fees, and loan terms. Then, compare the loan’s total cost to determine which is best.

Apply

Choose an offer and apply with the lender. Pre-approvals usually don’t hurt your credit score because lenders do a soft credit pull. However, when you choose a lender and formally apply, they’ll do a hard credit pull, so be sure you choose the lender you want to use.

H4: Seek a Co-signer (If Needed)

If you can’t get approved on your own, consider a co-signer. This may limit your lender options as not all lenders allow co-signers on personal loans. But, if you have a low credit score or your debt-to-income ratio high, a co-signer may increase your chances of approval.

FAQs

How Much Interest Will I Pay on Personal Loans?

On average, personal loans have a 10%+ interest rate. However, the rate you get depends on your qualifying factors and how much you borrow. You may pay more or less interest depending on what lenders offer.

How Do You Calculate Total Interest on a Loan?

To calculate interest paid on a loan, take the principal amount (the loan amount) and multiply it by the interest rate. Next, multiply that number by the term in years to get total interest paid.

For example, if you borrow $10,000 at 10% for three years, you’d pay:

$10,000 x .10 = $1,000 x 3 years = $3,000 in interest

How Do You Calculate Your Expected Monthly Payment?

Using a personal loan calculator to determine your expected monthly payment is best. The calculation for a personal loan payment is complicated, and it’s best to have accurate numbers to determine your monthly payment.

How Are Personal Loans Different From Other Loans?

Personal loans are unsecured loans, so they don’t have collateral. They usually have fixed interest rates and monthly payments. You can use the funds for any purpose but need good credit to qualify.

What Can You Use a Personal Loan For?

You can use a personal loan for almost anything! Unlike a car loan or mortgage, you don’t have to use the funds for an intended purpose. Most lenders won’t ask how you’ll use the funds unless you have a high debt-to-income ratio and must use the funds to consolidate debt.

Pros and Cons of Personal Loan – The Bottom Line

Compare the pros and cons of personal loan options before borrowing one. Be sure you have an intended purpose and can’t save the funds yourself to save yourself from paying interest. Many options exist if you decide a personal loan is the right choice. Shop around to get the best rates and terms on an unsecured personal loan.