If you need money for a major purchase or want to consolidate existing debt and lower your interest rate, a personal loan may be the best solution. Before taking out a loan, make sure you understand the pros and cons, as well as the alternatives.
How does a personal loan work?
If you take out a personal loan, you will receive the funds in a lump sum. You will need to make monthly payments which will include principal and interest. It may take several years to repay the loan.
Personal loans generally do not require collateral. Interest rates on personal loans are generally lower than those on credit cards. People with lower credit scores are usually charged higher interest rates.
When should you consider a personal loan?
If you currently have high-interest credit card debt and are struggling to meet minimum payments, consolidating those balances into one personal loan can help. You’ll only have one monthly payment, and a lower interest rate could save you thousands of dollars in interest.
You may want to take out a personal loan to cover the cost of home repairs or improvements. This can be a good option if you don’t have significant net worth and can’t qualify for a home equity loan or home equity line of credit.
Even if you have significant equity, you may prefer to take out a personal loan. If you borrow against the equity in your home and don’t keep up with the payments, you can lose your home in the event of foreclosure.
When should you not take out a personal loan?
If you’re planning a wedding or vacation, save money for that purchase instead of incurring debt that you’ll be paying off for years. For unexpected medical expenses, consider an alternative, such as a low- or no-interest credit card specifically intended to be used for health costs.
If you want to buy a new car or finance education costs, you can take out a personal loan, but a car or student loan will probably be a better choice. A loan designed for a specific type of expense usually has more favorable terms than a personal loan.
Is the personal loan for you?
Before taking out a personal loan, consider your current monthly budget. If you’re struggling to manage multiple credit card payments, consolidating them into one personal loan can help.
If you’re planning on making an expensive purchase but cash is already tight, you might find it difficult to fit a loan into your budget. Ask yourself if the expense is really necessary. You may want to postpone the purchase or cut back on a project to avoid becoming overwhelmed with debt.