Personal loans are a type of lending instrument offered through banks, credit unions, and online lenders. They’re paid back, with interest, in installments, and there are few limitations to how the loan funds can be used. They’re also typically unsecured, meaning you don’t have to put up any property as collateral for the loan.
A personal loan is an important financial tool if you can find one from a reputable lender at a reasonable interest rate, and you can commit to making loan payments on time. However, if you only qualify for a loan with a high-interest rate or you feel you may have trouble paying it back, you may want to think twice before applying.
Are Personal Loans Bad?
Not necessarily. There are both advantages and disadvantages to personal loans. Here’s a look at some of the benefits of taking out a personal loan:
• Personal loans generally offer a wide range of borrowing limits, typically between $1,000 and $100,000.
• There is flexibility in how the funds can be spent, unlike a mortgage, which you must use to buy a house, or an auto loan, which must be used to purchase a car.
• Proceeds of personal loans can be used for a variety of purposes, from paying down credit card debt to making home improvements and more.
• Unsecured personal loans are offered by many lenders. There is no need to put any of your assets up as collateral for the loan, nor do you risk losing them should you default.
It’s important to weigh these benefits against potential disadvantages, and determine if it’s bad to get a personal loan for your financial needs. Here’s a look at some of the downsides of taking out a personal loan.
• Personal loans may not offer the lowest possible borrowing option. For example, you might be able to get a better rate on a home equity loan or a home equity line of credit (HELOC) if you have enough equity in your home. That said, both of those lending instruments use your house as collateral, so if you default, you could risk losing your home.
• Personal loans sometimes have fees or penalties that can increase the cost of borrowing. For example, origination fees on personal loans tend to be between 1% and 5%. Some lenders may charge prepayment penalties to ensure they don’t lose future interest payments if you pay off your loan early.
• When you take out a personal loan, you’re increasing your overall debt. If you have other debts, comfortably affording all your monthly payments can become a challenge. And missing payments or making late payments can have a negative impact on your credit score.
Recommended: What Is Considered a Bad Credit Score?
Pros and Cons of Personal Loans
Here’s a look at the pros and cons of personal loans at a glance:
| Pros of Personal Loans | Cons of Personal Loans |
|---|---|
| Wide range of loan amounts, usually between $1,000 and $100,000. | Interest rates may be higher than other types of loans, such as home equity loans or HELOCs. |
| Use of funds is flexible. Borrowers can use money from personal loans toward almost any purpose. | Fees and penalties can make borrowing more costly. |
| They are generally unsecured loans, which is beneficial to those who don’t want to put up collateral. | They increase your debt, potentially putting a strain on your budget. |
When Can It Be a Good Idea to Get a Personal Loan?
So when is a personal loan a good idea?
Debt Consolidation
One reason to take out a personal loan is as a credit debt consolidation loan to pay down high interest credit card debt. The average credit card interest rate as of August 2024 is 27.62%. The current average personal loan interest rate, on the other hand, is 12.38% (if you have excellent credit you may pay less; if you have poor credit, you could pay more).
Consolidating high interest credit card debt with a lower-interest-rate personal loan may make your monthly payments more manageable and potentially save you money in interest payments over the life of the loan.
If you use a personal loan to pay down credit card debt, it’s a good idea not to use those credit cards to incur even more debt.
Home Improvement
Using a personal loan to make improvements to your home may also be beneficial as home improvements can increase the value of your home, possibly offsetting the cost of borrowing.
When Can It Be a Bad Idea to Get a Personal Loan?
There are a number of cases when you may wonder if getting a loan is bad. Here’s a look at some situations when getting a personal loan may not be a good idea.
No Credit Check Loans
Most loans — including most personal loans — require a credit check. This helps your lender understand your creditworthiness, or how likely you are to repay your debts. Generally speaking, the healthier your credit, the more favorable your loan interest rates and terms. Those with poor or limited credit may find it difficult to qualify for a loan.
No credit check personal loans, on the other hand, look at your bank account balance or require you to pledge some asset as collateral to secure the loan.
The problem is that these loans also tend to be extremely expensive — interest rates can well exceed 100%, which is considered to be predatory. There’s a pretty good chance that borrowers who rely on no credit check loans won’t be able to pay their bills on time, which could trap them in a cycle of debt.
Recommended: How To Avoid Falling Victim To Predatory Loans
Cheaper Alternatives May Be Available
Before taking out a personal loan, consider whether there are cheaper alternatives. We’ve already mentioned home equity loans and HELOCs. You might also consider a no-interest credit card, which charges 0% interest for an introductory period typically lasting between 12 and 20 months. If you can pay off your debt in this time period, this may be a good option. But whatever balance you don’t pay off in time may revert to the card’s regular rate, which is likely high.
You Are Not Good at Managing Debt
If you’re not good at managing debt, think twice before taking on more. And if you use your personal loan to consolidate credit card debt, you’ll want to be careful about racking up new credit card bills.
Discretionary Spending
Borrowing money for discretionary spending, such as vacations or an engagement ring generally isn’t a good idea. While these things are nice, they are not necessarily worth jeopardizing your financial wellbeing. Instead of borrowing to pay for big-ticket items like these, you may be better off saving for them in advance as a part of your regular budget.
Borrowing Money for Investments
It’s generally not a good idea to borrow money to make investments. By nature, investments are risky, and you are not guaranteed a return. Should the investment lose money instead of gain, you’ll be responsible for paying off your debt regardless of the investment loss.
The Takeaway
So are personal loans bad? The answer depends on how you plan to use the loan. Personal loans can be useful tools for purposes like consolidating credit card debt, making home improvements, and more.
Any time you’re considering a loan, it’s important to understand if it will meet your needs, what it will cost you, and whether there are any better alternatives out there.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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