From debt repayment to funding an unexpected expense (like a medical bill), to home improvements and large expenses (like paying for a wedding), taking out a personal loan can be a great strategy to get instant access to the funds to do so.
However, depending on your financial habits, a personal loan isn’t always the best choice. Read on to understand exactly what a personal loan is, and if it makes sense for your current situation and future financial goals.
What is a Personal Loan?
A personal loan is a relatively easy loan to apply and qualify for based on your credit history and income, especially in comparison to other home and auto loans. And, unlike other loans, which have restrictions on how you can use the funds, the money from a personal loan can be used for pretty much anything, making them useful for everything from home improvements to debt repayment.
How Do Personal Loans Work?
Personal loans are a type of installment loan, meaning borrowers can apply to receive a fixed amount of cash as a lump sum, and pay it back (with interest) via monthly payments throughout the term of the loan.
The process to secure a personal loan varies from lender to lender, with amounts ranging from $1,500 to $100,000, and repayment periods ranging from 12 to 84 months. Once you’ve repaid your loan, your account is closed and you’ll need to reapply for a new personal loan if you’d like to access additional cash.
Does a Personal Loan Make Sense For Me?
A personal loan is a debt, so it should go without saying that personal loans should only be accessed to fill a real financial need, and not for the sake of having extra cash on hand for frivolous spending.
That being said, if you have good credit and a steady cash flow to make monthly payments to repay the loan, there are a few situations where a personal loan can be a smart, strategic tool in helping you reach your financial goals faster.
Pay Off High-Interest Debt
If you have a lot of credit card debt that’s accumulating additional high interest charges each month, leveraging a personal loan to pay that balance off in full can actually save you money. For example, if you’re able to secure a personal loan with an interest rate that’s lower than that of your credit cards, you can pay off your high-interest credit card debts in full, and consolidate those monthly payments to one personal loan bill each month, at a much lower interest rate.
Fund Home Improvements
If the home improvement project you have in mind will add value to your home (ie: increase its equity), a personal loan can be a great alternative to a traditional HELOC or Home Equity Loan, given you won’t have to rack up credit card debt or put up your home as collateral to fund the project.
When to Consider Alternatives
Personal loans typically have higher monthly payment amounts than the average minimum monthly payment for a credit card. So, if you know you won’t be able to comfortably afford meeting the monthly payments for your personal loan, you may want to reconsider to ensure you don’t miss payments or default on your loan, which can ruin your credit score and any future financial opportunities.
Additionally, it’s important to remember that taking out a personal loan will increase your debt until that loan is repaid. You should also be honest with yourself and think: if I pay off my credit cards with a personal loan, will I responsibly manage the newly freed up credit limit available to me? For overspenders, this can offer an opportunity to rack up even more charges, digging themselves even deeper into debt.
The Bottom Line
Taking out a personal loan isn’t always right for everyone. If you have a habit of overspending and don’t urgently need the money, it may be best to consider building up your savings, instead, rather than taking on new monthly payments that you may not be able to afford for the entire repayment term of the loan.
However, if you need instant access to a large sum of cash, have good credit and will be able to afford the loan’s monthly payments, a personal loan can be a good choice for you. Just be sure to get quotes from several lenders to compare interest rates and loan terms to ensure you’re getting the best possible rate.
The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, we advise you to consult with a licensed advisor.
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