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When you are in need of money, a personal loan may be a good option.
Personal loans can provide you with the cash you need to cover unexpected expenses or debt consolidation.
However, there are some negatives that you need to understand before you apply.
In this post, I share with you the most important pros and cons of personal loans.
In the end, you will be able to make an informed decision about whether or not this type of loan is right for you.
Table of Contents
11 Pros And Cons Of Personal Loans
What Are Personal Loans?
A personal loan is a fixed-term loan that you can borrow from banks, credit unions, online lenders, and other financial institutions.
The loan term of a personal loan can vary, but is typically between one and five years.
Personal loans can be used for many purposes, including consolidating debt, paying for unexpected expenses, or financing a large purchase.
6 Pros Of Personal Loans
There are many benefits of personal loans.
Here are the biggest ones to consider.
#1. Ability To Consolidate Debt
One of the biggest advantages of personal loans is that they can be used for debt consolidation.
If you have multiple debts with high interest rates, a personal loan can help you save money by consolidating those debts into one loan with a lower rate.
For example, if you have various types of debt, like medical bills, credit card debt, an installment loan, and other loans, you can combine them all into one personal loan and have one monthly payment.
By putting multiple debts into one loan, you make your life easier.
#2. Lower Interest Rate
Another big advantage of personal loans is that they typically have a lower interest rate than credit cards.
Credit cards typically have an interest rate between 15% and 30%.
- Read now: Here are the pros and cons of credit cards
- Read now: Learn the biggest credit card mistakes people make
Personal loans, on the other hand, typically have an interest rate between 5% and 9%.
So, if you need to borrow money for a large purchase or to consolidate debt, a personal loan can save you a significant amount of money in interest payments.
#3. No Collateral Requirements
There are two types of personal loans, a secured loan and an unsecured personal loan.
Most personal loans are unsecured personal loans which means there is no collateral backing up the loan.
Collateral is a fancy way of saying you are putting personal property up for the bank or credit union to take in case you default in paying back the loan.
Common examples of personal property are your house, your car, or even your savings account.
With the benefit of not having to put down collateral however means you will pay higher interest rates because of the higher risk.
With a secured personal loan, you will get competitive interest rates since they are not as risky for the lender.
As long as you know you can make on time payments for the life of the loan, taking out secured loans is the better option.
#4. Higher Limits
Taking out a personal loan typically offers higher debt limit than that of a credit card.
This means you can fund larger projects that other revolving credit might not offer.
Of course there is a downside to this as you can easily get yourself into financial trouble if you take out too large of a loan.
One of the best personal loan advantages is the flexibility they offer.
You can use the personal loan funds for anything you want, from a debt consolidation loan, to making home improvements.
Or if you want to buy a car, you might find a personal loan offers you a better interest rate.
The bottom line is taking out a personal loan can be done for whatever purpose you want.
#6. Build Credit
Finally, a personal loan goes on your credit report and as a result, is reported to the credit bureaus.
This is a great way for poor credit or low credit scores to improve their credit history.
As long as you make your monthly payments on time, you will build good credit over time.
Of course the opposite is true as well.
If you skip your monthly payments, you will hurt your credit score.
5 Cons Of Personal Loans
While there are many advantages of personal loans, there are also negatives.
Here are the biggest disadvantages of personal loans you need to know before you make a decision to get one.
#1. Don’t Stop You From Overspending
The biggest downside to personal loans is your risk getting to more debt with them.
They are simply another way for you to borrow money and if you don’t have the means to make the monthly payment amount, you could end up ruining your credit over time.
So before you take out a personal loan and incur more unnecessary debt, make sure understand your financial situation, that you need the money and you can pay it back.
#2. Higher Interest Rate
While personal loans offer a lower interest rates compared to credit cards, they might not be the best choice.
For example, home equity loans tend to have more competitive rates and you can write off the interest you pay on your taxes.
So don’t just think that a personal loan is your best option because a home equity loan might make more sense for you.
#3. Additional Fees
Another drawback of personal loans is the added fees you pay for borrowing money.
Many lenders require you pay an origination fee on the amount you borrow.
There might even be loan processing fees and application fees as well.
Finally, some personal loans have a prepayment penalty.
This means if you try to pay off your loan early, you will get charged a fee.
So if you decide to go down the route of getting a personal loan, make sure you understand the added fees you might be charged.
#4. Higher Monthly Payments
One of the biggest cons of personal loans is they can have higher monthly payments.
This is because the loan is for a fixed period of time that you need to pay it back by.
With your credit card balances, you can pay these back over as many months or years as you like.
But with this and the higher interest rates you pay, you will be putting yourself in a much worse financial situation.
So before you take out a personal loan, understand what you monthly payment will be, and make sure you can afford to make it.
#5. Shady Personal Loan Companies
Finally, there are some shady loan companies out there.
They can gouge you with origination fees as well as prepayment penalties.
Because of this, it is important you do your homework and find and online lender that you can trust.
My favorite is PersonalLoans.com.
They offer many loan products at competitive rates.
They even have a good rating from the Better Business Bureau, which is saying a lot because many lenders have poor ratings.
There are the biggest pros and cons of personal loans you need to know.
In the right situation for the right person, this type of loan can be the perfect way to borrow money.
But at the same time, if you aren’t careful, you can hurt your credit and add a lot of stress to your life.
So make sure you understand what you are getting yourself into before you take out a personal loan.
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I have over 15 years experience in the financial services industry and 20 years investing in the stock market. I have both my undergrad and graduate degrees in Finance, and am FINRA Series 65 licensed and have a Certificate in Financial Planning.
Visit my About Me page to learn more about me and why I am your trusted personal finance expert.