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Pros and cons of personal loans

Consider whether a personal loan is the best loan for your needs

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There are numerous ways to borrow money these days, and the right option for you depends on how much money you need, your credit rating and the purpose of your loan.

Personal loans, also called installment loans, are unique because they are typically not secured by collateral (although secured personal loans do exist) and they give you a lump sum of cash instead of a line of credit to borrow against. That said, there are pros and cons of personal loans to consider, just like with any other financial product.


Key insights 

  • Personal loans are popular since they come with fixed interest rates, fixed monthly payments and a set repayment schedule.
  • Personal loans are more predictable than credit cards, which charge variable interest rates and let you make payments in any amount equal to or above the minimum amount due.
  • Potential downsides of personal loans include lack of payment flexibility, strict borrower requirements and the potential for high interest rates if you have less-than-perfect credit.

Advantages of personal loans

Personal loans give borrowers a lump sum of cash, and you can then use the funds however you see fit. That said, the purpose of a personal loan can play a role in the amount offered and the interest rates that apply. Lenders will ask what the money is for, or how you plan to use it, during the loan application process.

With these details in mind, here are some of the main advantages of personal loans over other types of loans:

  • Wide range of loan amounts: Depending on the lender, you may be able to borrow as little as $1,500 or up to $100,000. This broad range makes it easy to access the exact amount of money you need.
  • Online preapproval: Many personal lenders let you "check your rate" and gauge your approval odds before you apply. This can help you see the rates and terms you may be offered without a hard inquiry on your credit report.
  • Fixed interest rates: Personal loans typically have fixed interest rates instead of variable rates that fluctuate with the market.
  • Lower rates than credit cards: The Federal Reserve shows the average credit card account had a rate of 20.68% as of May 2023, compared to 11.48% for 24-month personal loans.
  • Fixed monthly payments: Because interest rates are fixed and personal loans come with a set repayment schedule, monthly payments are predictable and stay the same until the loan is paid off.
  • Flexibility: You can use a personal loan for nearly any purpose, whether you want to finance a wedding or a vacation or you need to consolidate and pay down high-interest debt. Personal loans are also commonly used for home renovations, medical expenses, adoption fees, costs for IVF fertility treatment and more.
  • No collateral requirement: While home equity loans and home equity lines of credit (HELOCs) require you to use the value of your home as collateral, most personal loans do not have any collateral requirements.

» MORE: Interest rates and how they work

Disadvantages of a personal loan

There are some notable downsides to personal loans, as well as plenty of reasons to consider other financial products. The unfortunate truth is personal loans add more debt to your budget, and more debt can lead to financial consequences and even hardship down the line.

The main disadvantages of personal loans can vary from person to person, but may include:

  • Consequences of late payments: While personal loans can help build credit, the opposite is also true. Not only will late payments on a loan negatively impact your credit score, but fees and penalties can add up quickly if you’re not making your monthly payments.
  • No payment flexibility: While credit cards let you make only a minimum required payment if you need to, personal loans require the same set monthly payment throughout the life of the loan.
  • Origination fees and other hidden fees: Many personal loans charge origination fees that can be as high as 10% of the loan amount. Also, watch out for other hidden fees like prepayment penalties.
  • Potential for high interest rates: While personal loans for excellent credit can offer exceptionally low rates and great terms, the same cannot be said when it comes to personal loans for fair credit or bad credit. In fact, some personal loans have fixed interest rates as high as 35.99%.
  • Strict eligibility requirements: Personal loans can sometimes have stricter eligibility requirements than other financial products, ​​meaning those with poor credit or a short financial history may not qualify.

Long-term personal loans

Many personal loans offer repayment terms that last up to 60 or 84 months, but there are also long-term personal loans that let you pay down debt for up to 144 months. This means you could borrow money for a full kitchen remodel, a new backyard pool, wedding expenses and more, then pay down the amount you owe over 12 full years.

However, depending on the lender, long-term loans may be offered for some purposes and not others. For example, LightStream lets borrowers repay amounts borrowed over up to 144 months if they're getting a loan for home improvements or a boat or RV, yet their debt consolidation loans and wedding loans are only offered in terms of up to 84 months.

While long-term personal loans can offer the financing you need, there are special considerations that come into play when you agree to a repayment term that lasts 10 years or longer.

Pros

  • Smaller monthly payments with a longer repayment timeline
  • Borrow more than you might have been able to afford with a shorter term
  • Lock in fixed interest rates that will not change, even over many years

Cons

  • Pay more interest over the life of the loan
  • May be stuck paying a monthly payment for longer than you need to
  • Longer repayment timelines may not be offered for all loan purposes

When does a personal loan make sense?

Andrew Harris of Jenius Bank says that, when used responsibly, personal loans can be valuable financial tools in a variety of situations. For example, installment loans can be utilized for home renovations, large purchases or life celebrations like a wedding or a dream vacation.

"The important thing is borrowing responsibly: not borrowing more than you need and making payments on time," he said.

With lower rates than the majority of credit cards, personal loans can help you finance a big purchase or handle an unexpected expense without wiping out your savings, added Harris.

The important thing is borrowing responsibly: not borrowing more than you need and making payments on time.”
— Andrew Harris, Jenius Bank

Personal loans can also be an excellent tool for debt consolidation since you can lock in one consistent loan payment instead of having to make several payments across multiple debts.

Not only that, but personal loans let you pay the same interest rate and same monthly payment for the life of the loan (often up to seven years or longer), whereas balance transfer credit cards that offer a 0% annual percentage rate (APR) only do so for up to 21 months before reverting your account back to the high variable rates they normally charge.

» MORE: Personal loan vs. credit card: Which is better?

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    FAQ

    Can personal loans help improve my credit score?

    A personal loan can help improve your credit score if you treat credit responsibly and never miss a monthly payment, according to FICO. An installment loan can also help your "credit mix," which is another factor used to determine FICO scores.

    Is it safe to get a personal loan?

    Getting a personal loan is just as safe as applying for any other financial product, although you'll want to make sure you're applying with a reputable lender. Before you apply for a personal loan, you should take the time to read lender reviews on sites like ConsumerAffairs and search the Consumer Financial Protection Bureau’s complaint database to check for worrying trends.

    Are there any types of loans I should avoid?

    Avoid payday loans, cash advances on a credit card and other high-interest loans that will cost you big in terms of fees and interest over the long run.

    Bottom line

    Personal loans can be a way to fund a planned or unexpected expense, but you need to carefully consider the cons of taking on additional debt.

    For example, while a personal loan for excellent credit can come with low rates and fair repayment terms, personal loans for bad credit tend to charge exorbitant rates and high fees. If your credit score is in the lower range and you have the option to wait it out, you may want to skip borrowing right now and work on improving your credit score first.

    Either way, Harris says the best lenders will be more than happy to walk you through the process. You can borrow money with a traditional bank or credit union near your home or seek out an online lender that offers phone support and online chat. No matter which you choose, having access to a person you can reach out to with questions is crucial when you're planning to borrow money and enter a repayment agreement that could last several months or years.

    "Asking questions is an essential part of the loan process, and you want to make sure the people on the other side of the phone, or screen, are ready and eager to help if you have questions or run into issues during the loan process," said Harris.


    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. Federal Reserve, "Consumer Credit - G.19." Accessed Aug. 7, 2023.
    2. Consumer Financial Protection Bureau, "What is a personal installment loan?" Accessed Aug. 7, 2023.
    3. Federal Trade Commission, "Home Equity Loans and Home Equity Lines of Credit." Accessed Aug. 7, 2023.
    4. FICO, "What's in my FICO Scores?" Accessed Aug. 7, 2023.
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