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While we often think of any type of borrowing as a bad move, the reality is that there are several benefits of getting a personal loan. Some personal loan benefits include flexibility, potentially lower interest rates and the ability to meet expenses you might otherwise have trouble covering.
Personal loans aren’t for everyone, but they can be a smart move, depending on your situation. Here’s what you need to know about personal loans and the potential benefits of getting one.
What is a personal loan?
A personal loan is money you borrow that you must then repay over a certain period of time. In many cases, it’s possible to get a personal loan for just about anything you want. For instance, you could get a personal loan to cover the cost of home improvements, pay off medical bills or consolidate your debt. While lenders generally won’t provide money for gambling or illegal purposes, you can usually get a loan to cover most expenses.
Secured vs. unsecured personal loans
There are two main types of personal loans:
1. Secured personal loans: This type of personal loan requires some type of collateral. If you get a loan from your bank, you might have to put a certain amount in a CD as security. Or, you might secure a personal loan with your car or some other asset. If you don’t make payments, the lender can take your collateral to offset what you owe.
2. Unsecured personal loans: One of the biggest benefits of getting an unsecured personal loan is that you aren’t risking an asset. If you can’t pay, the lender has little recourse beyond sending your account to collections or suing you to try to collect what it owes. You haven’t tied the debt to an asset, so there’s a little less risk to you. However, because of this, lenders may require charger a higher interest rate or require a better credit score. Just remember, when you miss payments, it is reported to the credit bureau and can cause your credit score to decrease.
However, there are many lenders willing to provide unsecured personal loans at reasonable rates. Carefully consider which type is likely to best fit your needs.
What are the benefits of getting a personal loan?
There are several personal loan benefits to consider as you decide if getting one is the right path for you. Flexibility is one big benefit of obtaining a personal loan, but there are some other advantages as well.
1. Personal loans can be used for multiple purposes
When you get a personal loan, it can be used for almost any personal expense. There are a few exceptions, but, for the most part, you can use the money how you want. Some of the ways you can use personal loans include:
- Debt consolidation
- Unexpected expenses
- Making a big purchase
- Paying for a wedding
- Going on vacation
- Buying a car
You might need to share a primary purpose for the loan, but if there’s money left over when you meet that purpose, you can usually use the money for something else.
However, while you can use a personal loan for a wide variety of purposes, it’s still an investment and one that you want to make wisely. It’s smart to use them for things you need rather than things you simply want, like a luxury item or a vacation. A personal loan is still debt that will need to be paid off.
2. Compared to credit cards, personal loans tend to have lower rates and higher borrowing limits
In many cases, it’s possible to get a personal loan for a larger amount than you might have available on your credit cards. Additionally, many personal loans can have rates that are lower than credit card rates, though this is not always the case. The average APR on a personal loan ranges from 10% to 28% in 2019, while the average APR on a credit card ranges from 13.12% to 22.99%.
Realize, though, that the best deals are available to those with good credit and solid incomes. If you have poor credit, or your income doesn’t meet the requirements, you might be stuck with smaller loans and higher interest rates.
3. Using a personal loan can help to improve your credit score
Another benefit of getting a personal loan is the fact that it can improve your credit score. When you make your payments on time and pay the full amount required, you build your credit history.
On top of that, an installment personal loan creates more diversity in the types of accounts you have, since it’s different from the revolving debt seen with credit cards. Your credit mix can impact your score, so having different types of debt and making your payments on time can give you a bit of a boost.
4. Personal loans follow a predictable payment schedule
With credit cards, your repayment schedule is based on a minimum payment, and it can change as you pay down your balance. Of course, when you keep using your credit cards without paying off the balance, that also changes how much you pay each month.
Without knowing exactly when you’ll pay off your debt, you could find yourself struggling to feel like you’re making progress. Plus, if you only make the minimum payment on a credit card, you’ll end up spending much more on interest — and being in debt for longer.
The set payment schedule offered by personal loans can let you see exactly when you’ll be done paying off your debt, and it also allows you to see exactly how much interest you’ll pay.
Personal loan drawbacks
Even though there are a lot of personal loan benefits, it’s also important to be aware of the drawbacks. Here’s what to consider before moving forward:
- Some loans carry higher interest rates: If you have poor credit, you might pay a much higher interest rate — even higher than credit card rates. Additionally, if you get a small, short-term loan, you could pay rates similar to payday loans.
- You may have to pay origination fees: Some lenders charge origination fees that can add to the cost of the loan over time. Origination fees can range from 1% to 6% of the total loan amount.
- You could lose some benefits: If you use a personal loan to pay off business debt or pay down your student loans, you won’t be able to deduct the interest on your taxes. Business and student loan interest payments are tax deductible, while the interest paid on personal loans is not.
- It’s possible to end up in more debt: Watch out if you use a personal loan to pay off high-rate credit cards. If you free up space on your credit cards and then max them out again, you’re in even more debt than you were to begin with.
- You could ruin your credit score: When you miss payments, that information is reported to the credit bureaus and you could end up seeing a drop in your credit score.
- Creditors could sue you: If you aren’t able to repay your loan, a lender could decide to sue you, and the result could include wage garnishment.
Make sure you understand the potential pitfalls of personal loans before you decide to take one.
What to know before you apply
Before you apply for a personal loan, make sure you understand what you’re using the money for, as well as how much you really need. Try to avoid borrowing more than you can repay, and make sure you can handle the monthly payments along with your other obligations.
Don’t forget to compare lenders to find the best personal loan for you. Look at multiple lenders and compare interest rates, origination fees and other terms. Carefully consider the situation so you can choose the loan that will work best in your circumstances.