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What is the best time to consider personal loans? good idea?

They can be expensive However, they’re usually the best choice.

By Tim Parker

Updated 12 November 2021

Reviewed by Janet Berry-Johnson

A personal loan can be used for almost anything. Some lenders might ask you what you intend doing with your funds, but others will just need to know if you have the ability to pay back the loan. Though personal loans aren’t inexpensive but they are an option for you for a wide range of situations. Find out which one is best for you.

The most important takeaways

Personal loans can be used for almost any purpose.

Contrary to car loans, personal loans are usually not secured by collateral.

Personal loans can be less expensive than credit cards and some other types of loans but more expensive than others.

What are the Personal Loans and how they work

Some types of loans are specifically arranged for a specific purchase. You can buy a home using a mortgage, buy automobiles by using an auto loan or pay for college with an undergraduate loan. When you take out a mortgage, your house serves as the collateral. Similar to an auto loan the vehicle you purchase will serve as the collateral.

But a personal loan often has no collateral. Because it is unsecured by property that the lender can seize in case you default on the loan the lender is taking a higher risk and will likely be able to charge you a higher rate of interest than with a mortgage or car loan. The amount you pay will be will depend on a number of factors, including your credit score and debt-to-income ratio.1

Personal Factors affecting the Interest Rate of a Loan

Investopedia / Lara Antal

Personal loans are also available in some cases. The collateral might be your bank account, your car, or other property. The secured personal loan may be easier to get and have a somewhat lower interest rate than an unsecure one. As with the other types of secure loan it is possible to lose your collateral if unable to keep up with the repayments.

Even with an unsecured personal loan Naturally failure to pay on time payments can be harmful to your credit score and could limit your ability to obtain credit in the future. FICO, the company behind the most popular credit score, says that your credit history is the single most important factor in its formula, which accounts for 35% of the credit score.2

What are the best times to consider a personal loan

Before you decide to take out an individual loan, you’ll want to consider whether there may be cheaper ways to take out the loan. A few good reasons to choose the personal loan are:

You don’t have and couldn’t be eligible for a credit card.

The credit limits of your credit cards do not meet your current borrowing needs.

Personal loan is your least expensive borrowing option.

There is no collateral to offer.

You may also think about a personal loan if you need to borrow over a limited and defined amount of time. Personal loans generally range between 12 and 60 months.3 For instance, if you have an unpaid amount due to you within two years, but you do not have enough cash flow in the meantime, a two-year personal loan may be a viable option to bridge that gap.

For instance, here are five situations where an individual loan might make sense.

1. Consolidating Credit Card Debt

If you have a large sum for one of your credit cards that have higher interest, getting a personal loan to pay these off could help you save money. For example, as of this moment, the average interest rate for a credit card is 19.49 percent, while the average rate on a personal loan is 9.41%.1 The difference in rates should enable you to pay down the balance faster and pay less interest overall. Additionally, it’s simpler to track and pay off one debt obligation rather than multiple ones.

However, a personal loan is not your only option. Instead, you might be able to transfer your balances to a new credit card with an interest rate that is lower If you meet the requirements. Some balance transfer offers even eliminate interest during a promotional period of six months or more.

2. Paying Off Other High-Interest Debts

Though the personal loan is more costly than some other types of loans however, it’s not necessarily the most expensive. If you have an payday loan, for example it will likely have a much higher interest rate than a personal loan from banks. If you also have an old personal loan with a higher interest rate than what you’re eligible for, replacing it with the new loan could help you save cash. However, before you make the switch make sure you check if there is a penalty for prepayment on the original loan or any application or origination fees for the new one. The fees may be significant.

3. The financing of a home Improvement or Big Purchase

If you’re buying new appliances, installing a brand new furnace, or are making another important purchase, getting a personal loan is more affordable than financing through the seller or putting the cost on credit card. However, if you have any equity built up on your property, taking out a home-equity loan or a home equity line of credit might be less expensive still. Of course, those are both secured debts and you’ll be putting your house on the line.

4. The cost of an Major Life Event

As with any major purchase, financing an expensive event, such as a bar or bat mitzvah, an important anniversary celebration, or a wedding, may be less costly If you can pay for the event with a personal loan instead of credit cards. According to a survey in 2021 conducted by Brides and Investopedia, one in five U.S. couples will use loans or investments to help finance their wedding. While these weddings are important, as they are, you might be thinking about reducing your budget some if it means you’ll be in debt for years to come. In the same way, taking out a loan to pay for a vacation might not be the best idea, unless it’s the holiday of the lifetime.4

A personal loan will help you improve your credit score if you are able to make every payment on time. Otherwise, it will hurt your score.

5. Enhancing Your Credit Score

The act of taking out a personal loan and repaying it promptly could increase your score on credit, particularly when you have a history of missed payments on other loans. If your credit report is mostly the credit cards, then taking out the personal loan could also improve the “credit blend.” Having different types of loans and proving that you’re able to handle them with care is considered to be an advantage for your score.5

That said, borrowing money that you don’t need in the hope of improving your credit score is a risky proposition. Better to keep paying all others bills promptly while also trying to maintain a low percent of your credit’s utilization (the amount of credit you are currently using compared with the amount that’s accessible to you).

The Bottom Line

Personal loans can be useful given the right circumstances. However, they’re not cheap, and there are often better options. If you’re thinking of getting one, the Investopedia personal loan calculator can help you determine what it will cost you.

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