Personal loans can be used for almost anything. While some lenders might ask you what you intend to do with the money; others simply want to ensure that you can pay it back. Personal loans can be an option for many reasons, even though they are not cheap. We’ll help you decide if a personal loan is right for your needs.
How personal loans work
A specific purchase may be eligible for certain types of loans. A mortgage can be used to buy a house, an auto loan can finance a car, or an education loan can be used to pay for college. Your home is the collateral for a mortgage loan. Similar to a mortgage loan, your home will serve as collateral.
A personal loan is often without collateral. The lender will charge you more interest on a personal loan because it is not secured by any property the company can seize in the event of default. The rate you pay will depend on a variety of factors including your credit score, debt-to-income ratio and credit score.
In certain cases, secured personal loans may also be available. Your bank account, car or other collateral could be used as collateral. Secured personal loans are easier to get and have a lower interest rate than unsecured ones. If you have difficulty paying the monthly payments, your security could be lost.
Failure to timely pay your personal bank loan can cause damage to your credit score. FICO, the company that produces the most used credit report, claims that your payment history makes up 35% of your credit history.
What are the benefits of a personal loan?
Consider other ways to borrow money before you make a decision about a personal loan. These are acceptable reasons to take out a private loan.
A low-interest credit card is not available to you if you don’t have it.
Your borrowing needs may not be met by the credit limits of your credit cards.
A personal loan is the best option for you.
There is no collateral that you can provide.
1. Consolidating Credit Card Debt
A personal loan can be a great way to save money if you have a large balance on credit cards that have high interest rates. For example, the average credit card interest rate is 19.49% while the personal bank loan average rate is 9.41%.
The difference in interest should help you pay off the balance quicker and save money. It’s easier to pay off one debt obligation than multiple.
A personal loan isn’t your only option. If you are eligible, you might be able to transfer your current balances to a credit card with a lower rate of interest. Balance transfer offers may even allow you to waive interest for up to half a year.
2. Repayment of other high-interest debts
Although a personal loan can be more costly than other types of loans it doesn’t have to be the most expensive. An online payday loan will likely have a higher interest rate than a loan from a bank. You could also save money if your personal loan has an older interest rate than you are eligible for. However, before you make this decision, check to see if there are any prepayment penalties or application or origination charges on the old loan. These fees are often quite substantial.
3. Major Life Event
Finance an expensive event like a bar or bat mitzvah party, significant milestone anniversary party, wedding or even a bar or bat mitzvah could be cheaper if you take out an unsecured loan than a card. A survey done by Brides and Investopedia in 2021 found that one fifth of American couples used loans or investments to pay for their wedding. You might consider scaling back if you have to take on debt over the years. If you’re on the ultimate vacation, borrowing money to finance it may not be a wise idea.
A personal loan can help you improve your credit score. This is especially true if there are any past missed payments. If your credit report shows mostly personal credit card debt, adding a loan might also help your “credit mix.” Having many types of loans, and showing that you can handle them responsibly, is recognized as an advantage for your credit score.
It is dangerous to borrow money you don’t need in the hopes of improving your credit score. It is better to pay your other bills on-time and maintain a low rate of credit utilization (the amount of credit that you are currently using compared to what’s available).
The bottom line
If you have the right circumstances, personal loans may be helpful. However, they can be costly and there are better options. Investopedia’s cash loan calculator can help determine the cost of one if you are considering it.