Key takeaways

  • A personal loan can fund expenses such as debt consolidation or medical costs.
  • Personal loans tend to carry lower interest rates than credit cards, which can make them more affordable for borrowers.
  • Before deciding to get a personal loan, you must consider potential downsides, such as high interest rates, steep fees and a hit to your credit score if used incorrectly.

Personal loan funds can be used for a number of purposes, including debt consolidation and medical expenses. They can also be a good solution if you need funds fast. Some lenders can deposit funds into your account as fast as the next business day. Plus, average rates are typically lower than those of other forms of debt, like credit cards.

But like all financial products, personal loans have drawbacks as well. For example, some lenders charge high fees, which can greatly increase your borrowing costs. Before you take one out, you should weigh the pros against the cons to determine whether it’s the right financing option for you.

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  • One lump sum.
  • Fast funding time.
  • No collateral requirement.
  • Lower interest rates.
  • Flexibility and versatility.
  • Extended loan terms.
  • Easier to manage.
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  • Interest rates can be higher than alternatives.
  • More eligibility requirements.
  • Fees and penalties can be high.
  • Additional monthly payment.
  • Increased debt load.
  • Higher monthly payments than credit cards.
  • Potential credit damage.

Advantages of personal loans

Personal loans can offer benefits over other types of loans. Below are a few advantages of using this type of financing over other options.

One lump sum

Because you get the loan all at once, it can be easier to make a large purchase, consolidate debt or otherwise use the loan all at once. Plus, you’ll get a fixed interest rate and predictable monthly payment, making the loan easier to manage.

Fast funding times

Personal loans generally have faster approval and payment times than secured loans. That makes them useful for emergencies or other situations where you need money quickly. Some lenders can deposit the loan proceeds into your bank account as soon as the next business day.

No collateral requirement

Unsecured personal loans don’t require collateral to get approved. If you cannot repay an unsecured loan according to the agreed-upon terms with your lender, you’ll face significant financial and credit consequences.

However, secured loans require you to back the balance with an asset (collateral), like your home or car. If you fail to pay, the lender could seize your asset to repay the balance.

With an unsecured loan, a lender can’t take your collateral if you fail to repay the loan.

Lower interest rates

Personal loans often come with lower interest rates than credit cards. As of July 2024, the average personal loan rate is 12.36 percent, while the average credit card rate is 20.71 percent.

Borrowers with excellent credit scores can qualify for personal loan rates of around 10.73 percent to 12.50 percent. You may also qualify for a higher loan amount than the limit on your credit cards.

You may save on interest if you have good credit and take out a personal loan instead of a credit card. But that’s only the case if you would carry a balance on your credit card. If you can use your credit card and pay it off during the grace period, you may avoid paying interest at all.

Flexibility and versatility

Some loans can only be used for a certain purpose. For example, if you take out a car loan, you can only use it to buy a vehicle. Personal loans can be used for many purposes, from consolidating debt to paying medical bills.

A personal loan can be a good alternative if you want to finance a major purchase but don’t want to be locked into how you use the money. Before applying, check with your lender on the approved uses for the loan.

Extended loan terms

Unlike short-term loans like payday loans and others that charge high interest rates, personal loans range from two to 10 years, depending on the lender. Consequently, you could be offered a reasonable monthly payment and ample time to repay what you borrow.

Longer loan terms can make the monthly payment more affordable. Just keep in mind that the longer your loan term, the more interest you’ll pay over the life of the loan.

Easier to manage

Some people use personal loans to consolidate debt, such as multiple credit card accounts. A personal loan with a single, fixed-rate monthly payment is easier to manage than several credit cards with different interest rates, payment due dates and other variables.

Borrowers who qualify for a personal loan with a lower interest rate than their credit cards can streamline their monthly payments and save money.

You can save thousands of dollars in interest if you qualify for a personal loan with a lower interest rate than your current debt.

Disadvantages of personal loans

A personal loan isn’t the right financial move for every situation.

Interest rates can be higher than alternatives

Interest rates for personal loans are not always the lowest available. This is especially true for borrowers with poor credit.

The lower your credit, the more likely a lender will charge you a high interest rate. As a result, you could end up paying thousands of dollars more in interest than someone with good credit. A secured loan might come with a lower rate.

More eligibility requirements

Personal loans can have more strict requirements than other types of funding options. Fewer lenders will be available if you have poor credit or a short financial history. By comparison, if you apply for a home equity loan, the lender will likely focus more on your home’s value than your credit score.

Adding a co-signer or co-borrower with a higher credit score than you may strengthen your approval odds. However, some lenders do not allow this.

Fees and penalties can be high

Personal loan fees and penalties can drive up the cost of borrowing. Some loans have origination fees of 1 percent to 12 percent of the loan amount. The fees, which cover loan processing, can either be rolled into the loan or subtracted from the amount disbursed to the borrower.

Some lenders charge prepayment penalties if you pay the balance off before the end of your loan term. Before applying, review all fees and penalties of any personal loans you are considering.

Additional monthly payment

When you take out a personal loan, you add another payment to your budget. Before taking out a loan, make sure the payment fits comfortably within your current and future financial plans. Also, account for the interest rate, principal amount and fees when calculating your monthly payment.

A personal loan can strain your budget if you borrow more than you can afford.

Increased debt load

Personal loans can be a tool for consolidating debt such as credit card balances, but they do not address the cause of the debt. Paying your credit cards off with a personal loan frees up your available credit limit. If you’re not careful, it can be tempting to rack up more debt rather than focusing solely on paying it off.

Although taking out a personal loan can help you consolidate high-interest debt, it can cause you to go deeper into debt if you don’t address bad spending habits.

Higher monthly payments than credit cards

Credit cards come with small minimum monthly payments and no deadline for paying your balance off in full. Personal loans require a higher fixed monthly payment and must be paid off by the end of the loan term.

If you consolidate credit card debt into a personal loan, you’ll have to adjust to the higher payments and the loan payoff timeline or risk defaulting.

Higher monthly payments can be more difficult to manage depending on your finances. As a result, you might be at higher risk of defaulting on the loan.

Potential credit damage

When you apply for a loan the lender will conduct a hard credit inquiry, which will knock your score down a few points. And if you fall behind on payments, your credit score will drop significantly.

However, the initial dip doesn’t last long. Your score should grow as you make monthly payments and pay down your debt. Your repayment history is the largest percentage — 35 percent — of your FICO Score and your amount owed makes up 30 percent.

Weak repayment history and a high debt-to-income ratio will likely result in a significant drop in credit. That can make it difficult to get approved for mortgages and car loans.

Should I get a personal loan?

Personal loans are an attractive option, especially if you need quick cash. But as Bankrate senior loans writer Denny Ceizyk explains, they aren’t the best financial move for everyone.

A personal loan is a good choice if you have room in your budget for a fixed payment for two to seven years and a steady, reliable income. It’s a great tool for consolidating credit card debt, as long as you don’t charge the cards up later. You’ll want to avoid personal loans if your income is unstable or you need payment flexibility (like you have with credit card minimum payments). — Denny Ceizyk

When a personal loan might be right for you

Once you’ve investigated the options available to you and your potential rates, here’s how to discern whether a personal loan might make sense for your situation:

  • You have a strong credit score: The lowest interest rates are reserved for borrowers who have good credit.
  • You want to pay off high-interest debt: Personal loans are a good way to consolidate and pay off costly credit card debt.
  • You’ll use the funds toward necessary expenses: Other good reasons to use personal loans include paying for emergency expenses or remodeling your home.

When to look for an alternative

Personal loans are not the only source of financial support, and loan alternatives might be a better fit for some circumstances. Here are three main situations where a personal loan can result in future financial hardship.

  1. You have a habit of overspending: Paying your credit cards off with a personal loan may not make sense if you’ll immediately begin building up a new credit card balance.
  2. You can’t afford the monthly payments: Consider a personal loan’s repayment timeline and monthly payments. Use a loan calculator to determine whether or not you can afford the monthly payments for the term you’ll spend paying it off.
  3. You don’t need the money urgently: It might make sense to build up your savings to pay for a large purchase instead of taking out a personal loan and making payments with interest for many years.

The bottom line

Securing a personal loan involves serious financial obligations and must be treated as such. Make a plan for how you will use the funds and, more importantly, how you’ll repay them, accounting for interest.

If you’re considering a personal loan, get quotes from several lenders to compare interest rates and loan terms. Don’t forget to read the fine print, including fees and penalties. Once you have all the data, decide if the benefits of a personal loan outweigh the drawbacks before making a commitment.