Often, loans have a clear purpose — think home loans, auto loans and student loans. But with a personal loan, the possibilities are more open-ended.
Technically speaking, with a personal loan "you can use the money virtually any way you see fit, from consolidating credit card debt to financing home renovations," said U.S. News & World Report. But because personal loans do have drawbacks and risks, it is an option that you should still be mindful about choosing.
When can a personal loan be a good idea?
In addition to their flexibility and versatility, personal loans offer interest rates that are "often lower than credit card rates, and they provide a predictable monthly payment and fast funding — sometimes the same day you apply," said Bankrate. This can make them a worthwhile option for certain scenarios, such as consolidating high-interest debt, paying for a home improvement project or quickly covering an unexpected expense, like an emergency car or home repair.
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More broadly speaking, you might consider a personal loan if it is "your least expensive borrowing option" and it aligns with your financial priorities, said Investopedia.
When should you consider another option?
Personal loans do have cons. "Some lenders charge high fees, and the monthly payment may be steep if you only qualify for a short repayment term," said Bankrate. Further, there may be less expensive borrowing options, especially if you do not have great credit. Since personal loans are unsecured loans, meaning they are not backed by collateral — like, say, a mortgage or an auto loan — the lender "takes a greater risk and will most likely charge a higher interest rate than a secured loan," said Investopedia.
There are also select purposes for which you generally cannot use personal loans. These include educational expenses like tuition and student loan debt, a down payment on a house, investing and gambling.
You should think twice before borrowing funds for something that is not essential, like a vacation. "Going into debt for something you simply want is a bad idea" because the expense "will end up costing more than if you bought it with cash since you'll pay interest on the amount borrowed," said Bankrate.
What should you consider before taking out a personal loan?
If you are weighing the benefits of a personal loan, take into account the following when determining whether or not it makes sense for your situation:
- Your credit score, as this will influence the rate you get
- Whether or not you can afford the monthly payments
- If you can find better terms or a lower interest rate elsewhere
- What fees, if any, the lender charges
- Whether the funds are going toward a necessary expense or, if used for consolidation, will effectively address your debt
