A personal loan is a convenient financing tool offered by credit unions, banks, and other lenders. If you’re thinking about applying for a loan, the following comparison of the pros and cons of personal loans can help you decide whether it’s the best borrowing option for your needs.
7 Pros of Personal Loans
Personal loans are popular because they offer several important advantages compared with other types of loans and credit. Here are the positive features to consider before you make a borrowing decision.
1. Personal Loans Are Relatively Easy to Obtain
Obtaining a personal loan isn’t usually hard. Most lenders will approve your loan application if you have a credit score of at least 600, which is considered a fair score. As part of the requirements for a personal loan, your lender will likely verify your employment and income to make sure you can repay the money you borrow.
2. A Personal Loan Can Be Used for Nearly Anything
Perhaps one of the best things about personal loans is that there are usually no restrictions on what you can do with the money you borrow. You could use it to pay for a vacation, buy a big ticket item, or just about anything else. The interest on personal loans may be tax deductible when used for certain purposes, like qualified education or business expenses.
3. Lower Interest Rates than Credit Cards
While credit cards are convenient, they usually have interest rates that are higher than personal loans. And if you maintain a monthly credit card balance, your balance may continue to grow from the compounding of interest even if you aren’t making any additional purchases.
4. Quick Approval Times
After applying for a personal loan, approvals are usually made within one to seven days. This makes a personal loan a quick way to get the cash you need.
5. Can Help You Build Your Credit
The monthly payments you make to repay a personal loan will be reported to the credit bureaus. As long as you make your monthly payments before their due dates, they will be beneficial to your credit score.
6. Can Be Used to Consolidate Debt
You may be able to use a personal loan to consolidate credit card debt and other loans. Your new personal loan may give you lower rates and a repayment term that better suits your budget. Keeping up with one monthly payment is usually easier than keeping up with multiple payments.
7. Collateral Is Usually Not Required
Personal loans are sometimes referred to as “signature loans” because your signature and promise to repay are usually all you need. If you have at least fair credit, you can usually get an unsecured loan with no collateral needed.
5 Cons of Personal Loans
Personal loans may not be the best borrowing option for every situation. Due to potential fees, interest, and other factors, another borrowing option may make more sense.
1. You May Have to Pay Fees
Depending on your lender, you may be required to pay fees for your personal loan. Common fees include an origination fee, a prepayment fee if you pay off your loan early, and missed payment fees. It’s important to find out if your lender charges any fees before you apply.
2. Other Borrowing Options May Have Lower Interest Rates
Although personal loans usually have lower interest rates than credit cards, other borrowing options may have even lower rates. If you’re a homeowner, for example, you may be able to get a lower rate with either a home equity loan or a home equity line of credit (HELOC).
3. Can Result In Unnecessary Debt
Because it’s relatively easy to obtain a personal loan, you may end up borrowing more than you need. The additional debt you take on could strain your budget, which could result in missed payments or default. This will have negative impacts on your credit.
4. Will Require a Hard Credit Check
When you apply for a personal loan, your credit will be checked. This “hard credit check,” as it’s known, will cause a temporary decrease in your credit score. Hard credit checks only affect your credit score for 12 months, but stay on your credit report for two years.
5. Collateral May Be Needed for Lower Credit Scores
If you don’t have good enough credit or have a history of missed payments, your lender may request collateral to secure your personal loan funds. This could be in the form of a cash deposit or the funds already in a savings or certificate account.
Before You Apply for a Personal Loan
There are some important things to consider before you apply for a personal loan. Depending on your reason for needing the loan, it may make sense to wait until your credit score or financial situation improves.
Do You Have a Good Credit Score?
Although you may be able to qualify for a personal loan with a fair credit score, you may be able to get a lower interest rate with a higher score. Your credit score is an indication of how risky you will be to lenders. Because of this, lenders tend to reward those with higher scores with the best interest rates.
Can You Afford the Monthly Payments?
Having another monthly payment to take care of may be challenging if you already have other debts. In addition to making sure you can afford the payment, each of your debts will most likely have different due dates. The more payments you have to make each month, the greater the chances that you may accidentally miss a payment.
Do You Need the Money Right Away?
Are you borrowing money for something you just want to buy, or is there an urgent need? If it’s something you don’t necessarily need to buy right away, you may be better off saving your money and buying it when you can pay cash for it. This will help you avoid a hard credit check and the chance of accidental missed payments harming your credit score.
Is a Personal Loan the Best Borrowing Option?
Now that you know the pros and cons of personal loans, you may want to consider whether a personal loan or a credit card is the best choice for you. Though personal loans are convenient and affordable, there are times when a credit card may be the better option, like when you have an emergency and need to make an immediate payment.
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