Should I Get a Personal Loan?
Posted On May 10, 2022 · Length of read: 6 minutes
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.
What Is a Personal Loan?
A personal loan is money borrowed from banks, credit unions and online lending companies to fund various needs, including:
- debt consolidation;
- home improvements and renovations;
- financing emergency expenses;
- making a large purchase; or
- wedding and vacation expenses.
A personal loan is paid out in lump sum and is typically between $100-$100,000. It’s not intended for or limited to a specific purpose in the way that student loans, car loans and mortgages are. These types of loans can only be used for specific expenses, such as education, the purchase of a vehicle or buying a home.
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 important to understand how to apply for a loan as well as the process for repaying a personal loan.
Applying for a Personal Loan
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 together 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 a personal loan if the loan is secured with collateral (i.e., a savings account) or a co-signer.
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 now 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 a personal loan. Origination fees may range from 1% to 8% of the loan amount.
Repaying a Personal Loan
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.
- Interest rates on personal loans are, on average, between 4.49% and 35.99%, but if you have an excellent credit history, you may receive a more competitive interest rate.
- Interest rates are either fixed, resulting in the same payment amount every month, or variable and may change month-to-month according to market conditions.
- Repayment periods, or the time a borrower has to pay back the loan, range from six months to seven years, although longer-term loans may be available.
What Are Personal Loans Used For?
Personal loans may be used for a wide variety of reasons, from debt consolidation to paying for a wedding, with restrictions varying by lender. The most common uses for personal loans, according to an article published by Chamber of Commerce, are:
- debt management, including credit card debt consolidation, at over 60% of all personal loans;
- home improvement (8%);
- a large purchase (3.5%);
- events such as weddings and vacations (3.5%); and
- other financial emergencies, such as medical bills (18%).
Let’s take a look at each of the top uses of personal loans 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.
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. When consolidating existing debt into a personal loan, several debts are consolidated into a single loan. Thus, using a personal loan for debt consolidation could result in you having only one loan.
Another reason is that personal loans may carry more competitive interest rates than your existing debt, especially 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 home improvement project can save you money. A personal loan may help reduce the burden of these costs.
And while you may be thinking the interest on a personal loan simply increases the cost of the project, it may be worth it, as you could get every dollar back and then some 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. Usually, 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.
However, 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. Likewise, a personal loan may require you to pay an origination fee upfront which creates an additional unexpected expense that you may not be able to afford.
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 with a personal loan given the potential for a longer pay-off term.
Wedding and Vacation Expenses
The average price for a wedding in 2021 was $28,000, an amount most people don’t have lying around.
Vacations aren’t cheap either. The average cost for a domestic flight is $234 and the global average per night for a hotel is $136. That’s $500 for a weekend away for one person, not including food and entertainment. For a family of four, that’s $2,000.
So if you’re hoping to spend quality time with your 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 with a personal loan given the interest charges.
When To Avoid Personal Loans
Despite all the reasons you might consider applying for a personal loan, there are situations where the answer to your question, “Should I get a personal loan?” might be “no.”
For instance, you may not want to apply for a personal loan 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 a loan and common reasons for applying for a personal loan (looking at you, credit card debt!). We also discussed when a personal loan may not make sense for you.
Whether you’re looking to consolidate debt or pay for your wedding, when considering 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?
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.