In the U.S., people have about $38,000 of personal debt on average.
That number may sound high, making you want to shy away from taking on more debt. However, debt’s not always a bad thing. A wisely chosen personal loan can help you reach your goals faster and put your financial life on the right track.
What should you know about personal loans before taking one out? As much as possible. The more informed you are, the better your decision will be.
In this guide, we’ll introduce you to the essentials of personal loans, and weigh the pros and cons. Read on to find out how you can make personal loans work for you — and when you should avoid them.
What Is a Personal Loan?
Borrowing money comes in lots of different forms. You may be familiar with credit cards, and might even have one or more of your own. However, a personal loan offers a valuable alternative way to borrow money responsibly.
With a personal loan, you get a large pool of money upfront. Then, you’ll pay it back over a set period of time using fixed monthly payments. The term for paying back the loan can range from one to seven years, and the interest rate will likely stay the same the entire time.
Types of Personal Loan
When you decide to take out a personal loan, you can choose one of two types.
In this type of loan, you don’t use collateral to back the loan. This is the most common type of personal loan.
Your lender will use your financial history to determine the terms of your loan. The interest rate for an unsecured loan will be a bit higher than the rate for a secured loan. However, the good thing about these loans is you don’t need to put anything at stake as collateral.
In a secured loan, your savings, car, home, or other valuable assets become collateral to back up the loan.
This typically gets you a lower interest rate, since the bank doesn’t take on as big of a risk with a secured loan. But if you can’t pay your loan back, you face the risk of losing your collateral. This loan is less risky for the bank but can be riskier for you.
Advantages of Personal Loans
Personal loans can be great in many ways. Here are just a few of the advantages to look forward to if you decide to take one out.
Simple Application Process
With personal loans, the process for applying is quick and easy. You’ll also hear back about whether or not you got approved quickly. There’s no stressful process or drawn-out waiting period.
This is helpful when you need a large amount of money quickly. After approval, it can take just a few days for the money to land in your bank account.
As many people know, bigger isn’t always better when it comes to loans. You don’t want to take out more than you need since this means paying back more interest over time. But you also need to make sure your loan covers what you need it to cover.
The good news about personal loans is that they come in just about any amount you could need. You can borrow as little as $1,000 or as much as $100,000.
Of course, the exact amount you can get will depend on getting approved by the bank. But the flexibility in loan amounts makes it far easier to get just what you need.
These loans also offer high flexibility in terms of what you can use them for. Many loans, like car and student loans, only have one purpose. But with a personal loan, you can put that money to any use you need.
Ideal for Paying off Debt
Get a loan to pay off debt? It might sound like a bad idea — but it’s actually a great financial decision in many cases.
Since you can get personal loans with bad credit, these loans can help you pay off your credit cards and other loans to build your credit back up. They can also save you immensely on interest in the process.
You can use a personal loan to consolidate your debt, so you only have one loan to pay off with a set interest rate. Then, you’ll know what your single monthly payment is, and can pay it off gradually without the stress of managing multiple payments.
Disadvantages of Personal Loans
While personal loans come with powerful pros, there are also some cons to be aware of. Here’s what you should know.
No Prepayment Allowed
Many personal loans involve “prepayment penalties.” This means that if you pay off the full balance early to avoid interest, you’ll end up paying a penalty. It’s often best to pay the loan off in instalments as planned, even though this means paying interest each month.
Possible High-Interest Rates
Many personal loans have great interest rates, but not all of them do.
With bad credit, you may have a hard time finding a reasonable rate. The advertised rate by lenders usually refers to the best possible rate. If you have bad credit or other financial history issues, your rate won’t be as low.
Limited Payment Flexibility
Credit cards allow you to pay back different amounts each month, depending on what you have available. But with a personal loan, you need to be able to pay back the fixed amount each month. If you can’t, you face losing your collateral or possible lawsuits.
Ready to Try Getting a Personal Loan?
All types of loans have pros and cons. Personal loans do have some drawbacks, but for many borrowers, they’re the best choice for the situation.
Whether you’re paying for something big like a wedding or a remodel, or just paying down old debts, a personal loan can help you do it. Shop around at different lenders, so you can find out what’s available for you.
Looking for more ways to get your finances on track? Make sure to check out our Personal Finance blog section regularly for new financial tips!