Personal Loans Can Make Large Expenses Feel More Manageable—Here’s What You Should Know Before You Borrow
Used responsibly, personal loans can help improve your overall financial picture.
You’ve likely heard it before, but it never hurts to say it again: Having debt is not always a bad thing. One vital part of practicing financial wellness—maintaining a sturdy financial situation that supports your lifestyle and moves you closer to your goals—is knowing when loans or debt can work for you, rather than against you, and one huge area of borrowing that can absolutely work for you is personal loans.
Unlike mortgages (used for home-buying), car loans (used for buying cars), or student loans (used to pay educational expenses), personal loans can be used for almost any purpose—even debt consolidation. Used carefully, personal loans can help reduce your debt burden or otherwise further your financial wellness. As with any other type of debt, though, when taken out carelessly, personal loans can put you in a difficult situation.
Used well, personal loans are “giving you a little more flexibility and liquidity,” says Nancy DeRusso, SVP and head of coaching at Ayco, a Goldman Sachs company that provides employer-sponsored financial advising. Personal loans can help pay for a wedding or another large expense by offering an influx of cash without forcing people to dive into their emergency savings, DeRusso says; they can be used to make paying down debt more efficient, too.
As with all types of loans, it's important that you understand what you're getting into before you take out a personal loan. Do your research, study up, and borrow intentionally, and your future financial situation will reap the rewards.
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What is a personal loan?
A personal loan is a form of unsecured debt that delivers a lump sum of money—anywhere from $1,000 to $100,000—to borrowers. Personal loans are shorter-term, offered by banks, credit unions, private lenders, and other financial institutions, and paid back (with interest) by the borrower over an agreed-upon number of years. Most personal loan terms range from 24 months to 60 months, according to Bankrate, giving borrowers years to repay their debt.
Like a payday loan, a personal loan can be obtained relatively quickly. Unlike payday loans, personal loans typically require a credit check and/or proof of income, and borrowers often have more time (years, instead of weeks) to pay back the loan, typically in monthly payments. (Personal loans also tend to be larger than payday loans.) Personal loans sometimes come with fees, in addition to interest.
Understanding the difference between secured and unsecured debt here is important: Unsecured debt is not backed by collateral, meaning it often will have a higher interest rate than forms of secured debt (think mortgages or car loans), which have collateral that can be reclaimed by the lender if payments are not made as agreed. Most personal loans are unsecured, and thus tend to have higher interest rates than other types of loans; lenders may also be choosier in giving out these loans and offer them only to people with solid credit scores.
The good news is that personal loans can be used for anything. While using them to buy a car may not be advisable—you could likely get a better rate on a secured car loan—borrowers can use personal loans to consolidate debt or pay for a wedding, home renovation, vacation, adoption, or a number of other things.
Personal loan interest rates
Personal loan rates can vary based on your credit score and history, income, and other factors. They can sometimes be lower than credit card interest rates—hence their usefulness for debt consolidation, in which someone pays off multiple credit card bills with a personal loan and then has only one debt payment, ideally at a lower interest rate—but that’s not guaranteed.
Before you take out a personal loan, shop around for the best interest rate. According to Bankrate, personal loan interest rates can be as low as 6 percent or so or as high as 36 percent; as of July 2020, the average personal loan interest rate is 11.91 percent. The best personal loans have lower interest rates, but the lowest rates may only be available to borrowers with high credit scores or excellent credit histories. Even at an institution that offers low interest rates, those rates may vary based on how much money you borrow (many have minimum loan amounts) and how long your loan term is.
Even high personal loan rates may be lower than payday loan rates; if you can qualify for a personal loan, it’s likely a better option than a payday loan, which can have sky-high interest rates.
Should you take out a personal loan?
If you’re in need of cash quickly, a personal loan is a reliable option. Just crunch some numbers before you commit to it to be sure you’re able to pay it off, with interest, within the loan term, and try to preserve your credit score if it’s in the middle- to low-range to increase the likelihood of getting approved.
If you’re working to consolidate debt, check that you can get a lower interest rate on your personal loan than your other debt currently has. (Debt consolidation works best if the new loan has a lower rate than the other debt.) Having one payment, instead of payments on multiple different cards or loans, can give you a more structured payment plan and make debt repayment feel more manageable.
For those considering a personal loan as an alternative to dipping into savings (emergency or otherwise) to pay for a large expense, be sure this large expense is worth the debt. (This may not always be an option—some people take out personal loans to pay for medical procedures and other unavoidable expenses.) If the large expense is worth it and you’re confident you’ll be able to repay the loan handily, borrow away.