Should I Get a Personal Loan?

A personal loan can be a valuable financial tool in many different circumstances. It can help you finance major purchases, cover unexpected expenses, or pay down debt at advantageous interest rates. However, if they’re not properly managed, personal loans can also lead to major financial woes.

This guide will explain everything you need to know about personal loans, including what they are, why people use them, and how to use them safely and responsibly. It will also highlight situations in which taking out a personal loan might not be the wisest course of action, and offer wiser alternatives that protect your long-term financial interests.

What Is a Personal Loan?

A personal loan is a form of credit extended by a lender to a borrower. In a typical case, a borrower will request a specific amount of money and submit an application for the lender to review. If the lender approves the application, the lending institution will forward the loan amount to the borrower in a lump sum. The borrower then becomes responsible for repaying that sum, with interest, in regular instalments until the debt is cleared.

Features of Personal Loans

Personal loans come in two main types: secured and unsecured. Secured loans require the borrower to offer some type of asset as collateral. The financial institution will claim the asset if the borrower fails to repay the loan. Unsecured loans, which most borrowers prefer, do not require any such consideration. Instead, borrowers qualify by meeting the lender’s credit rating and proof of income standards.

All personal loans share three common features:

Some loans also charge borrowers an origination fee, which supplements interest as a type of compensation earned by the lender. Origination fees are usually expressed as a percentage of the loan principal. Not all loans and lenders charge them, but you should watch for ones that do as these fees can have a major impact on the lifetime cost of your loan.

You should also be aware of any fees and charges your lender may apply to loans you pay off early. Repaying a loan ahead of schedule denies the lender some of the interest they would otherwise have earned on the debt, which is why lenders sometimes add early termination fees. Similarly, you could incur penalties for late or missed payments. These stipulations will be specified in your loan’s terms and conditions, so ask the lender if they apply or consult your loan documents.

What Is a Good Time to Take out a Personal Loan?

While lenders may ask you how you plan to use the money, personal loans do not usually come with restrictions. You are free to assign the funding to any legal purpose you deem necessary.

That said, there are some common situations that prompt borrowers to take out personal loans. In some cases, a personal loan may offer financial advantages that make them a particularly good idea. Here are some examples:

Because your credit rating will go up if you pay back the loan promptly without missing any payments, and because loans can also reduce your overall credit utilization ratio, many consumers use personal loans as a means of improving their credit scores.

When Is a Personal Loan a Bad Idea?

Personal loans make less sense in other situations. Finance experts usually recommend avoiding them if you need the money for:

If you decide that a personal loan is right for your situation, take your time to research the industry’s many lenders. Online personal loan companies offer a vastly expanded range of options beyond traditional banks and credit unions. Thanks to this hyper-competitive landscape, borrowers with a solid income and good credit ratings can shop around for highly advantageous terms.