Are Personal Loans a Good Idea? Here Are the Pros and Cons

Should you get a personal loan?

In two words: it depends.

Personal loans can help you in a financial emergency or consolidate your debt, usually at lower rates than credit cards. Although, they may carry high lender fees and shorter repayment terms than you’re comfortable with.

Whether a personal loan is right for you boils down to your individual situation and goals for the money.

Personal loan pros

Personal loans bring many advantages for borrowers who need money quickly under reasonable terms.

Money upfront and fast

Once approved, you get your money upfront in a lump sum. And that can be signed, sealed, and delivered to your bank account in as little as one business day.

Comparatively low interest rates

Personal loans almost always have lower interest rates compared to credit cards.

The better your credit score, the lower your interest rates and higher your lending limits will be. For a personal loan, that could mean locking in a single-digit rate. Lower interest rates equate to paying less over the lifetime of the loan.

Stable payment structure

Personal loans allow you to borrow money with terms from one to seven years, and you pay it back in equal installments, usually on a monthly basis. This uniform structure allows borrowers to have something steady to budget around rather than a variable.

Security in an unsecured loan

The majority of personal loans classify as “unsecured,” meaning, they’re not secured by the collateral of your property. An inability to make your payments will hurt your credit score, but you won’t risk losing your house or car.

Being an unsecured loan shortens approval time since the lenders don’t need to appraise the value of your collateral. Your approval hinges on you have stable employment, regular income, and credit score.

Credit boost

Using your personal loan for debt consolidation can potentially raise your credit score. A borrower consolidating their debt will use their personal loan funding to pay off their credit card at a lower interest rate. Getting your credit card debt squared away lowers your utilization ratio and buoys your credit score.

Flexible funds

Personal loans typically don’t come with restrictions and the money can be used how you choose. Many borrowers will use their funds for consolidating debts, home improvement, or a milestone life event like a wedding. Some exceptions, like investing or paying college tuition, do exist.

Personal loan cons

Just like any type of lending product, personal loans have their drawbacks.

Raising your debt

Taking on a bigger debt load raises your debt-to-income (DTI) ratio. Higher DTI ratios can potentially limit how much money you can borrow and at what interest rate.

Costly fees and possible penalties

Lender origination fees on personal loans are drawn from the total loan amount and typically range between 1% to 12%. That’s something you need to account for when calculating how much you want to borrow.

It’s also important to know your loan terms in order to avoid any potential penalties. Some lenders will penalize you for paying off your loan early.

Hard credit pulls

Applying for a personal loan triggers a hard credit inquiry. Pulling those inquiries lowers your credit score in the short-term, impairing your financial profile. For this reason, you should shop multiple lenders to leverage the best rate and terms so you can minimized the hard credit pulls.

Stringent schedules

Although a fixed, scheduled repayment amount can be advantageous, it also lacks flexibility. Credit cards do offer minimum payment options that can help you make ends meet elsewhere if needed. If you’re unsure you can consistently make your fixed payments, another type of loan, like a HELOC, could be a better option.

Static credit

With a personal loan, you receive all your money as a lump sum. Then, you make even payments on the entire balance over the course of the loan term - regardless of how much you’ve spent. Whereas with a credit card, your only balance is what you’ve charged to it, within your approved credit limit.

The bottom line

Just like any type of financing, personal loans come with benefits and drawbacks for the borrower. Whether it’s a good choice depends on your individual situation and plan for the funds.

If you have strong credit, steady income, and are looking to consolidate high-interest debt, a personal loan could make a lot of sense. If you’re ready to take the next step, remember to shop with multiple lenders so you can negotiate better and lock in a lower interest rate, and carefully review all the loan’s terms and potential penalties before signing.