Personal Loans – Are They Right for You?
What Are Personal Loans and When Are They a Good Idea?
There are many different loans out there intended for specific purposes. You could be taking out a mortgage to buy a home, using an auto loan to purchase a car, or taking out a small business loan for your startup.
A personal loan, however, can be for any of these things—or something completely different. Sometimes they’re a great idea, and sometimes not so much. Let’s dive in to what personal loans are, and how they are most commonly used.
What are Personal Loans?
Unlike an auto loan or a mortgage, which are secured by the asset being financed, a personal loan is typically unsecured. Its approval is based mostly on the creditworthiness of the borrower.
Personal loans come with far more risk for the lender than the borrower. For example, if a borrower stops making payments on a car loan, eventually the lender will repossess the car. With a mortgage, the home could go into foreclosure. In the case of a personal loan, however, the lender has nothing to repossess or foreclose upon since nothing is securing the loan. As a result, lenders generally have higher interest rates, fees, or a higher bar for approval of personal loans.
What are Personal Loans Used For?
While other loans are used to purchase specific items or pay for something specific, personal loans can usually be used for anything you wish. They’re most commonly used as debt consolidation loans. In this case, a borrower would take out a personal loan to pay off credit card debt or other debt. Instead of making several payments each month to a variety of credit cards, a borrower can make just one payment under one, lower interest rate with a personal loan.
Repayment terms on a personal loan are usually shorter than other loans as well. A student loan, for example, may have terms up to 20 years. Conversely, a personal loan isn’t usually taken out for longer than five years.
Interest rates on a personal loan are often higher than other loans due to their unsecured status. Most lenders use a range of rates, with a minimum set. What an individual loan’s rate is depends on the creditworthiness of the borrower. Typically, rates range from around 5% to 35%.
Not every type of financial situation is good for a personal loan. If you have credit cards with low interest rates, for instance, you may end up paying more by consolidating your cards that are already at rates lower than your loan. It’s also a bad idea to take on unsecured personal debt if you’re already having a hard time making payments on other debt unless you’re able to lower your total monthly payment by doing so.
Before talking to your lender about a personal loan, take a good look at your finances and be realistic about what you want the personal loan for. It may help you—and it may not.
Andy Kearns is a Content Analyst for LendEDU and works to produce personal finance content to help educate consumers across the globe. When he’s not writing, you can find Andy cheering on the new and improved Lakers, or somewhere on a beach.