Personal Loans – Are They Right for You?

What Are Personal Loans and When Are They a Good Idea?

Are personal loans right for you?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%.

Conclusion

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.

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Mark B.
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Mark B.

If I consolidated my credit card debt into a personal loan, would that improve my credit score, assuming I paid the loan on time?

Andy Kearns
Guest
Andy Kearns

Hi Mark,

Assuming you paid the loan on time, then yes that would typically improve your credit score. Personal loans tend to create a more diverse mix of credit forms which can help improve your score. Also, since personal loans are considered installment loans, your credit utilization would drop as compared to having credit card debt. Note that if the personal loan lender does a hard credit check, though, it could reduce your score temporarily.

Stacy P.
Guest
Stacy P.

I’m kind of a newbie when it comes to loans and such. What’s the difference between a personal loan and a payday loan? I think they both are unsecured loans?

Andy Kearns
Guest
Andy Kearns

Hi Stacy,

Yes, both are considered unsecured but payday loans typically have much higher interest rates and very short repayment terms. Payday loans are usually targeted at people with poor credit who live paycheck-to-paycheck. Personal loans are geared toward creditworthy individuals and come with lower rates and repayment terms up to 3 or 5 years depending on the lender.

Myron F.
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Myron F.

I have a question on a personal loan. You mention in the post that rates on personal loans run from 5% to 35%. Is there a cap in some states that have a state usury law?

Andy Kearns
Guest
Andy Kearns

Hi Myron,

Yes, there are APR caps in some states that have a state usury law.

Kate P.
Guest
Kate P.

I have a question. Some lenders charge an origination fee from 1% to as high as 6%, besides a higher rate of interest. What factors would be considered to determine if an origination fee would be charged?

Andy Kearns
Guest
Andy Kearns

Hi Kate,

Some other factors that are typically considered by lenders to determine origination fees are the loan amount requested, the loan term (typically, the longer the loan term the higher the origination fee), and creditworthiness of the borrower (if you have good to excellent credit, you will normally have a lower origination fee amount).

Don G.
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Don G.

I settled on a personal loan about a month ago with a company online. They advertised that there were no fees charged on the loan, only the interest. When they gave me my money, they made a deposit into my checking account for 9,500.00 on a loan of 10,000.00. I contacted them and was told that all personal loans have an origination fee. Can they do this?

Andy Kearns
Guest
Andy Kearns

Hi Don,

Not all personal loans have an origination fee, but if they do, they typically take it out of the loan balance you are given. I am not sure why they would advertise no fee and then charge one to you.