Should I Get A Personal Loan?
Need to consolidate high-interest-rate credit card debt into one single loan? Facing a car repair that you can’t afford? Or` maybe you’re struggling with medical expenses that threaten to drain your savings. A personal loan can help you overcome these financial challenges.
Just be careful: Some personal loans come with high interest rates, while other lenders might charge steep fees. Be sure you know exactly how much your personal loan will cost before signing up.
But if you can find a personal loan at a reasonable interest rate, it might provide you with a solution to some of your financial problems.
What Is A Personal Loan?
A personal loan is an unsecured loan. This means that there is no collateral that a lender can make a claim on in case you stop making your payments.
This sets personal loans apart from secured loans such as mortgages and auto loans. If you take out a mortgage, your collateral is your home. With an auto loan, it’s your car. If you stop making your payments, your lender can foreclose on your home or repossess your car. If you stop making your payments on a personal loan, though, your lender has nothing to take.
Because of this, personal loans are considered riskier. That’s why they typically come with higher interest rates than what you’d get with a mortgage or auto loan.
In some ways, personal loans are like other types of debt. With a personal loan, you’ll make monthly payments until you repay what you’ve borrowed. You’ll also be charged interest that you’ll pay throughout the life of your loan. This interest is one way that your lender makes a profit on your personal loan.
When you’re approved for a personal loan, you’ll receive the loan amount in a lump sum payment. You can then use that money for whatever you’d like. Those options could include debt consolidation, in which you use the money from a personal loan to pay off credit card debt with higher interest rates, or expensive home improvements that you’d rather not fund with a credit card.
When Is A Personal Loan A Good Idea?
A personal loan might be a good idea depending on the financial challenges you face.
- Credit card debt: Are you struggling to pay off credit card debt? You can take out a personal loan and then use the funds from this loan to pay off your credit card balances. Yes, you’ll still need to repay your personal loan, but personal loans typically come with lower interest rates than credit cards. By paying your credit card debt with a personal loan, you’ll be swapping out a higher and multiple interest rates for a lower one. In some cases, your personal loan’s interest rate will be much lower, saving you hundreds of dollars or more in interest. Just be sure not to run up your credit card debt again after paying it off.
- Medical debt: Maybe you’re struggling to pay medical debt. You can pay off this debt with a personal loan before your medical providers send your account into collections. This is important: Your credit score could plummet if your medical bills are sent to a collection agency.
- A financial emergency: Your car’s transmission might need to be replaced, a fix that could cost thousands of dollars. And if you don’t have your car, you might struggle to get to work. A personal loan could give you the funds necessary to fix your car quickly if you don’t have money available for this repair. You’ll have to pay more for the repair because of the interest that comes with a personal loan, but the need for a quick repair might be more pressing than avoiding interest payments.
Pros Of Personal Loans
There are several benefits of personal loans:
- Relatively low interest rates: If your credit is solid, you could qualify for a personal loan with an interest rate that’s significantly lower than the rates of 20% or more that many credit cards charge.
- One lump sum: You’ll receive the funds from a personal loan in one payment. You’re then free to use these funds however you’d like.
- Easy repayment schedule: If you take out a fixed-rate personal loan – a loan in which your interest rate remains the same – your monthly payments won’t change over time. This makes it easy to budget for your payments.
When Is A Personal Loan A Bad Idea?
There are times when a personal loan might not be the best choice.
You shouldn’t apply for a personal loan for a want rather than a financial need if you’re not in a good position to do so. Maybe you want to book a cruise or take the family on a Florida vacation. Taking out a personal loan for pleasure trips isn’t a good choice if you have other financial needs to take care of.
A personal loan isn’t a good choice if your credit score is so damaged that you’ll be stuck with a higher interest rate. One of the benefits of personal loans is that they typically come with lower interest rates than credit cards. But if your credit score is so low that you only qualify for a personal loan with an interest rate of 20% or more, you should hold off on borrowing until you can improve your credit score.
A personal loan might be a bad choice, too, if you struggle with making your other monthly payments on time. If you have a history of making payments late, or skipping them completely, adding one more in the form of a personal loan could leave you with late fees and an even lower credit score.
Cons Of Personal Loans
As with all financial tools, personal loans come with some drawbacks:
- Eligibility requirements: You might not qualify for a personal loan if your credit score is too low, your income not sufficient and your debts too high. Lenders will check your credit score, credit reports, income and debt levels to determine if they’re comfortable lending to you.
- Fees and penalties: The fees that lenders charge vary, with some charging none and others a hefty amount. You can expect, though, to pay on average of 1% – 5% of what you’re borrowing. If you take out a personal loan for $10,000, you might pay $100 to $500 in origination fees. If you make a payment late, you might also face a late-payment fee. This fee will vary, too, but typically runs from $25 to $50.
- Another monthly payment and more debt: When you take out a personal loan, you add to your total debt load and become responsible for making another monthly payment. If you’ve struggled in the past to pay your bills on time, adding more debt and another monthly payment could bring financial pain. If you pay your personal loan 30 days or more past its due date, your lender will report a late payment to the national credit bureaus of Experian, Equifax and TransUnion, something that could cause your credit score to drop significantly.
Alternatives To Personal Loans
There are alternatives to personal loans.
If you own a home, you might be able to take out a home equity line of credit (HELOC) or home equity loan. These are loans that you take out against the equity you’ve built in your home. Equity is the difference between what you owe on your mortgage and what your home is worth. If you owe $200,000 on your mortgage and your home is worth $350,000, you have $150,000 of equity.
You can then borrow a portion of this equity, say 70% of it, as a home equity loan or HELOC. With a home equity loan, you’ll receive your payment, which you can spend on anything, in a lump sum. You’d then pay it back in monthly installments, with interest.
A HELOC acts more like a credit card. You’ll have a revolving line of credit with a limit based on the equity in your home. With a HELOC, you only pay back, again with interest, what you borrow. Rocket Mortgage® does not offer HELOCs at this time.
The benefit of a HELOC or home equity loan is that they typically come with lower interest rates than what you’d get with a personal loan. The challenge? You must own a home and you must have equity in that residence.
You might also apply for a personal line of credit with a bank. This is a revolving line of credit that you can access whenever you'd like, much like with a credit card. You only pay back what you borrow.
You can typically only borrow from a line of credit during a specific time, known as the draw period. Because lines of credit aren't secured by any collateral, most lenders will require a credit score of around 670 or higher. You can also expect to pay a higher interest rate because of this risk.
The amount of your line of credit will vary based on your credit score, income, debts and other factors. Most lenders, though, offer lines of credit ranging from $1,000 to $100,000.
You can also turn to your credit cards if you need to cover a financial emergency. This should be a last resort, though, unless you can pay off what you borrow on or before your card’s next due date. Credit card debt comes with high interest: You don’t want to carry a large balance from one month to the next.
The Bottom Line: A Personal Loan Can Be Worth It Depending On Your Unique Situation
If you’re facing a financial emergency, need to make an expensive home or car repair or want to consolidate high-interest-rate credit card debt, a personal loan might be a smart financial choice. Ready to search for the right personal loan? It’s time to apply for a loan with our friends at Rocket LoansSM.