Should I Get a Personal Loan?
7 min read
Updated on May 5, 2023
You have big dreams, but low funds. And how can you bring your ideas to life without cash?
If you’re asking this question, you might also ask, “Should I get a personal loan?” In which case, you might want to know:
- What is a personal loan?
- How does a personal loan work?
- What can I use a personal loan for?
- When should I avoid a personal loan?
- Is a personal loan right for me?
This article will help you to answer those various questions. Let's dive in!
What Is a Personal Loan?
A personal loan is money borrowed from banks, credit unions or online lending companies to fund various needs, from debt consolidation to medical bills to home renovations, and more.
It's paid out in a lump sum and amounts are typically between $1,000-$100,000. It’s not intended for or limited to a specific purpose in the way that student loans, car loans and mortgages are. Those types of loans can only be used for specific expenses, such as education, the purchase of a vehicle or buying a home.
But keep in mind that a personal loan is not revolving credit. A credit card provides on-going access to a certain amount of money that can be used as needed. Once the money is paid back, the same amount of money is once again available for use. With a personal loan, however, you receive the funds in full via a one-time deposit, and are liable for the full amount, whether used or not.
How Do Personal Loans Work?
When considering whether a personal loan is right for you, it’s particularly important to understand how to apply for a loan as well as the process for repaying the loan. We’ll give you an overview of both in this section.
Applying for a Personal Loan
In order to obtain a personal loan, you must apply with an online lender, bank, or credit union that offers personal loans. Applications may request that you provide your reason for requesting the loan or what you plan to do with the money if approved.
The application will then be approved or denied based on your credit report and existing debt-to-income ratio which, among other factors, determine your creditworthiness (i.e., the likelihood that the institution can depend on you to pay the loan back, in full and on time, including interest). If deemed creditworthy, you may be offered an unsecured loan, up to $100,000. However, if you have poor credit, you may still receive the personal loan if it's secured with collateral (i.e., a savings account or an automobile).
Once approved, funds are released as a lump sum and often as a direct cash deposit to the borrower’s bank account, typically within 1 to 14 days. The money may then be used at your discretion without the need to notify the lender of how the money is spent.
Note: some lenders may require an origination fee to cover the costs of processing the loan. Origination fees may range from 1% to 10% of the loan amount.
Repaying a Personal Loan
Let’s talk repayment, shall we? Here are some things to know.
Monthly repayment installments begin as soon as a personal loan is issued. The amount of your monthly payment is based on the loan terms, including the loan amount, interest rate and type of loan, as well as the length of time to repay the loan. If you have an excellent credit history, you may receive a more competitive interest rate.
Personal loans have either fixed or variable interest rates. Fixed interest rate means you have the same rate and payment amount every month. Variable interest rate means your rate may change month-to-month depending on market conditions, and this can change your payment amount as well.
Note: repayment periods, or the time a borrower has to pay back the personal loan, generally range from 6 months to 7 years. However, longer-term loans may be available.
What Are Personal Loans Used For?
Personal loans may be used for a wide variety of purposes (with restrictions varying by lender). Borrowers may seek a one to consolidate existing debt, finance major purchases, or even renovate their home.
Here are some common uses for personal loans:
- Debt consolidation (including credit card refinance)
- Home improvement
- Emergency expenses
- Large purchases
- Wedding and vacation expenses
Let’s take a look at each of these common uses in detail, including how funding your expenses with a personal loan may improve your financial situation.
Borrowers may use personal loans to consolidate existing debt, including amounts owed on credit cards. There are a few reasons why.
One reason to apply for a personal loan for debt consolidation purposes is to reduce the number of loans you must track and pay for individually. Consolidating existing debt into a personal loan means several debts are then combined into a single loan. Thus, using a personal loan for debt consolidation could result in you simplifying your debt by having one monthly payment.
Another reason is that personal loans may carry more competitive interest rates than your existing debt. Especially when it comes to credit card balances, which tend to carry higher interest rates than personal loans (and may quickly become overwhelming).
In other words, using a personal loan for debt consolidation may result in saved time and money (and who couldn’t use more of that?)
Another common reason to apply for a personal loan is to fund the remodeling or renovations of your home, from a new garage door (since your kid drove through your current door) to a new addition for your in-laws (yay….).
Whether you’re doing the project yourself and only paying for materials, or hiring a contractor, the right personal loan for a home improvement project could save you money by helping reduce the burden of the costs.
And while you may be thinking the interest on a loan simply increases the cost of the project, it may be worth it. This is thanks to a possible uptick in the resale value of your home following the completion of the project.
With a personal loan, you could fund your project today to make extra cash tomorrow. Plus, unlike home equity loans or home equity lines of credit (HELOC), personal loans don’t use your house as collateral.
Life is not always filled with sunshine and rainbows. Sometimes it asks you to pony up for an unplanned and thus unbudgeted expense. Often, it’s one you can’t afford.
You may use a personal loan to combat the overwhelm of these emergency expenses, which may include anything from hospital bills to car repairs that don’t allow for installment payments.
Although a personal loan could be beneficial to your financial situation since it allows you to pay down a debt balance over time, it may result in a total payment that’s higher than the original expense, thanks to interest charges. Additionally, you may be required to pay an origination fee for the loan. While origination fees are often taken from the loan itself and not required to be paid upfront, be sure to check the details of your loan to confirm.
Sometimes you just want something new or luxurious. You’re only human. Maybe your washing machine finally died, and your dryer is on its last breath. Maybe you want a new audio system for your home or car.
Your instinct could be to reach for your credit card to pay for the purchase, but the interest charged could wreak havoc on your personal finances if your balance is not paid down on time.
So, if you decide the large purchase is a necessity, one option is to fund it with a personal loan, which may offer more competitive interest rates than a credit card. The flip side is that you may pay more over time given the potential for a longer pay-off term.
Wedding and Vacation Expenses
The average cost of a wedding in 2022 was $30,000, an amount most people don’t have lying around. From dresses and tuxedos to food plates and venues – expenses can add up quickly.
Vacations aren’t cheap either. The average cost for a domestic flight in 2022 was $378 and the average per night for a hotel in the U.S. was $148. That’s almost $675 for a weekend away for one person, not including food and entertainment. Whoa!
So if you’re hoping to visit family and friends or you’re planning the wedding of your dreams but can’t afford to pay out of pocket, a personal loan may help you pay for the experiences and memories. But again, you may pay more over time due to given the interest charges.
When Should You Avoid a Personal Loan?
Despite all the reasons you might consider applying for one, there are situations where the answer to your question, “Should I get a personal loan?” might be “no.”
For instance, you may want to avoid applying in the following situations:
- You’re prone to overspending. If a paid-down credit card looks like a good opportunity for a shopping spree, a personal loan may not improve your financial situation since you could end up with more credit card debt on top of the personal loan.
- You’re looking for a way to pay for school. Lenders may have restrictions stating you cannot use a personal loan to pay for college. This is because they often offer specific student loan programs that may be better suited to your situation.
- You want to make a down payment on a home. Most lenders don’t allow you to use a personal loan as a home down payment as it increases your debt-to-income ratio. It also raises questions about your ability to meet your monthly mortgage payments.
Is a Personal Loan Right For You?
We’ve covered what a personal loan is, how it works, how to obtain one and common reasons for applying (looking at you, credit card debt!). We also discussed when it may not make sense for you.
Whether you’re looking to consolidate debt or pay for your wedding, when asking yourself, “Should I get a personal loan?”, remember to think about:
- Your credit history, current financial situation and goals, as these will impact the type of loan you may be offered (secured or unsecured), as well as the interest rate on the loan.
- Is your motive for considering a personal loan reasonable compared to the extra costs that may be incurred?
- Would a different type of loan make more sense?
Ultimately, you are responsible for paying back your loan, so it’s important to carefully consider your reasoning before going through the application process.
Explore Your Options through Splash
You deserve options. (Duh.) So we built a network of lenders to shop and compare personal loan rates. Checking your rate is quick and easy, plus it won’t impact your credit to see what you qualify for.1
The information provided in this blog post is not intended to provide legal, financial or tax advice. We recommend consulting with a financial adviser before making a major financial decision.