What Are the Benefits of Obtaining a Personal Loan?

Personal loan definition

A personal loan is a type of loan meant for personal use, whether that’s for debt consolidation, a wedding, a dream vacation or something else. It is usually unsecured, meaning you don’t need to provide any collateral to secure the loan. Instead, your credit score, income level and debt-to-income (DTI) ratio determine your eligibility and annual percentage rate (APR).

Personal loans generally have fixed interest rates and monthly payments. Depending on your lender, there may be fees, such as an origination fee and late payment fee.

Benefits of personal loans

Obtaining a personal loan can provide a number of benefits to borrowers looking for a financial lift. The process of applying for and obtaining a personal loan is much simpler than refinancing your home or taking out a home equity loan. Many qualified borrowers can get approved for a loan and funded within days rather than waiting for weeks. Other potential benefits of a personal loan include:

• Funds can be used for nearly anything
• Fast funding
• No collateral required
• Better interest rates than credit cards
• Can contribute to a healthy credit mix

While personal loans come with several perks, they might not be the best fit for everyone. Because creditworthiness plays a big part in a personal loan APR, you might be charged a high rate if your credit score is low. However, if you do have bad credit and need a personal loan, there are several lenders that may work with you.

Potential drawbacks of personal loans

While taking out a personal loan can be the right solution for the right situation, there are some potential downsides. Consider them carefully before taking out a loan.

• Debt: When you take out a loan of any kind, you’re agreeing to pay it back — typically with interest. While no one can see into the future, you can anticipate if you expect to take on more debt (such as if your vehicle is aging and you plan to replace it soon) at the same time you’ll be paying off your personal loan. You don’t want to take on more debt than you can comfortably pay back.
• Interest rate: If you don’t have a high credit score, you may have to pay a higher-than-ideal interest rate on your personal loan.
• Credit impact: Applying for a loan can negatively impact your credit score, but this is temporary. Doing all you can to improve your credit score, such as paying off your credit cards, before applying for a loan may lessen the blow to your score. Be sure to make on-time payments each month to keep your credit score healthy.
• Fees and penalties: In addition to interest, your loan may cost you even more, depending on the lender and product. Some lenders may charge an origination fee to process your loan application, for example, and some charge a prepayment penalty if you pay off the loan early. Be sure you understand your prospective loan terms before signing so you aren’t caught off guard by any potential extra expenses.

What can I use a personal loan for?

Personal loans can be used for almost anything. During the application process, a lender might ask about the purpose of the loan, but there are usually few restrictions on how you can use the funds. For example, many borrowers use a personal loan for debt consolidation, paying off higher-interest debts and making a single payment each month.

 Avoid using personal loans for investing or business expenses.

Here are a few more ideas on what you can use the loan for:

• Home remodeling
• Wedding costs
• Vacation costs
• Medical costs for you or a pet
• Emergency expenses
• Moving costs
• Vehicle financing for a motorcycle, RV, ATV or dirt bike

There are some expenses that you should avoid using personal loans for, though. According to Leslie H. Tayne, a financial attorney at Tayne Law Group in Melville, New York: “You should also avoid using a personal loan to invest. Investing has risks, so it's possible for you to lose money. Plus, you’ll still be on the hook for the loan balance even if your investment tanks.”

Additionally, she advises against using a personal loan to make a down payment on a home or to fund a business. “Personal and business money should always be kept separate for tax and legal reasons,” she said. “Plus, a personal loan won’t help you build business credit.”

Alternatives to personal loans

Personal loans can fund many different types of purchases, but they aren’t the right choice for every expense. And if you don’t qualify for a low rate, you may consider these alternatives instead:

• Delaying your purchase to save cash: While it’s no fun to put off a trip or home remodel until you save up cash, it can help you save money in the long run. Plus, the extra time spent saving could help you secure a better deal.
• Credit cards: While a credit card can have a higher APR, it can also be easier to qualify for a new account. Monthly bills will vary on your debt load, but the minimum payment required is typically low and easier to pay than on a fixed personal loan.
• Home equity loans: Home equity loans and home equity lines of credit (HELOC) have strict eligibility requirements, but both can give you access to a higher amount of money than a personal loan. This can help you conquer your full home remodel to-do list without worrying about taking out an additional loan.
• Crowdfunding: For unexpected emergencies, such as a medical bill or vet expense, crowdfunding can work in your favor. Crowdfunding platforms make it easy to share your story and get donations for your cause. Crowdfunding platforms do take a small chunk of the money, but you won’t have to worry about repaying people.

Bottom line

Personal loans make it easier to pay for unexpected expenses and larger purchases. Taking out a personal loan is less risky than getting a loan that uses your home as collateral. However, a personal loan isn’t the best financial choice for everyone. Consider the costs, benefits and drawbacks of different types of personal loans and alternatives so you can make the right decision for you.