Should I Get a Personal Loan?

What is a personal loan?

A personal loan is money borrowed from a financial institution. It’s an installment loan, which means that a lender gives you a set amount of money as a lump sum, and you’ll repay the loan with interest over a fixed period of time. Lenders charge interest and other fees, including origination fees, to cover the processing of a loan.  Interest is typically expressed as an annual percentage rate (APR), which is the annual cost of the loan (including interest and fees) expressed as a percentage of the amount borrowed.

Many lenders report payment activity to the three main credit bureaus: TransUnion, Experian and Equifax. Getting a personal loan may help you build good credit if you make payments on time each month.

» READ MORE: How to use a credit-builder loan to establish credit

What can a personal loan be used for?

Personal loans can be used for almost any purpose, including:

• Debt consolidation
• Medical bills and emergencies
• Home renovations
• Vacations
• Weddings

What can’t you use a personal loan for?

Personal loans generally can’t be used for:

• Educational purposes
• Buying a home
• Investments
• Business expenses

Before taking out a personal loan, check with the lender(s) you’re interested in for any restrictions.

Pros and cons of personal loans

Consider the pros and cons before taking out a personal loan.

Benefits of personal loans

• Fast funds: For eligible applicants, many lenders can offer preapproval and funding within a few days.
• Range of repayment timelines: You can typically repay personal loans over one to seven years.
• Ease the debt load: Consolidating several debts into a single personal loan can make repayment more manageable and help you get out of debt in less time.
• Possibly better rates than credit cards: Personal loans generally come with fixed interest rates, unlike credit cards, which have variable rates, and they tend to have better APRs, depending on your creditworthiness.

» LEARN MORE: 4 best low-interest personal loans

Risks of personal loans

1. More stringent eligibility requirements: Most personal loans require a good to excellent credit score (or a FICO score of 670 to 850), verifiable income and low debt-to-income ratio.
2. Missed payments are costly: Unlike credit cards, there’s no minimum payment option. Instead, you must make the full monthly payment on time or risk receiving a high penalty fee and a hit to your credit score.
3. Increased debt load: If you use a personal loan to cover wedding or remodeling costs, you’re adding a costly debt bill to your budget.

How to qualify for a personal loan

Lenders typically look closely at your financial situation when deciding whether to approve your application for a personal loan. Your credit history and score have a direct effect on the APR you’ll receive.

Required personal loan documents

Lenders ask for documents and information before approving your loan. These can include:

Some lenders will not approve applicants with low FICO credit scores, no matter their income, employment or evidence of savings.

• Proof of employment: Lenders may want to see copies of your most recent pay stubs and a letter from your employer proving that you have a steady job.
• Tax returns: You may have to provide a copy of your tax returns to show that you have a reliable income that's large enough to afford the monthly payments for your loan.
• Other income sources: If you have investment income, earn money from a pension or receive Social Security benefits, you may have to provide proof of that income.
• Evidence of savings and cash: Lenders want reassurance that you have additional funds available to help you make monthly loan payments if your income decreases. They may ask you for recent bank statements that show you have money set aside for emergencies.

Additional eligibility requirements

Lenders look at your credit history to determine whether you have a record of making on-time loan payments. Borrowers with higher credit scores generally have an easier time getting approved for personal loans.

Most lenders require borrowers to have credit scores in the good range (or a FICO score of 670 to 739), though borrowers with higher credit scores (or a FICO score of 740 to 850) will typically qualify for the most  favorable terms. However, there are also lenders who will provide loans to people with poor or fair credit.

Is a personal loan right for you?

Getting a personal loan may solve a short-term problem, but it's important to remember that payments may stretch out for years into the future.

“First off, ask yourself if the item you're taking a loan against is really a need,” said Derek Sall, founder of LifeAndMyFinances, which was acquired by Moneyzine in 2023. “If not, then it's likely not worth the hassle of the debt and the additional interest you're going to owe on it. If you're taking out a personal loan to pay off high-interest debt, that's a smart move, but be sure there isn't a prepayment penalty.”

FAQ

Bottom line

Personal loans are an important financial tool that can help you save money on high-interest debt, make large purchases or finance other needs, such as remodeling your home. While taking out a personal loan to consolidate high-interest debt may make sense, nonurgent expenses like a vacation may not always be good reasons for getting a loan.

Before getting a loan, be sure to check your credit report so you understand whether you're likely to be approved for a good interest rate. Consider your unique personal financial circumstances and be sure to compare offers from different lenders.