Are Personal Loans Bad? Here’s What You Should Know

Our posts may contain links from our affiliate partners. This supports helps support the site as we donate 10% of all profits to sustainability organizations that align with our values. However, this does not influence our opinions or ratings. Please read our Terms and Conditions for more information.

Money makes the world go round, or so they say. I wish there wasn’t so much truth to that statement, but unfortunately, almost everything costs money. If you are anything like me, you may have found yourself in a situation where you needed some extra cash.

Whether it be for unexpected expenses, debt consolidation, home renovations, or another major purchase that requires a lump sum of money. I don’t always have this money just hanging out in my savings account and have turned to a personal loan for help. 

Personal loan funds can be a great solution, but are personal loans bad? Borrowing money is a big commitment, and there are a lot of things to consider.

Is a Personal Loan a Good Idea?

Some people may wonder, “Are personal loans bad?” The short answer is not always. There are a lot of good reasons to get a personal loan. And there are also a few situations in which a personal loan may not be such a great idea. Either way, it is definitely a good idea to consider a few things and do some research before securing that personal loan.

This article details everything you need to know about getting a personal loan. It will also discuss good reasons to get personal loans and a few reasons that may not be so great. So, buckle up and get ready to get “personal” about personal loans. See what I did there?

What is a Personal Loan?

A personal loan is a loan obtained from banks, credit unions, or lenders that the borrower must pay back over a period of time. The loan is paid back in monthly payments over an agreed-upon loan term: typically two to seven years. A personal loan isn’t free money, though. There is typically an interest rate, which is based on the borrower’s creditworthiness.

These interest rates can range from around 6% and 36%. These types of loans are different that something like home equity loans, which allow people to borrow money against their homes based on value. A home equity loan is great for homeowners, but not everyone has that luxury. A personal loan can work for those who can’t get something like a home equity loan.

See Related: Best Business Loans for Solar Energy

Good Reasons to Get a Personal Loan

Good Reasons to Get a Personal Loan Graphics

A personal loan can be a great option for a variety of reasons. They can provide much-needed cash in emergency situations and are a great option for paying off high-interest loans and credit cards the borrower might already have. Check out a few good reasons to get a personal loan.

Debt Consolidation

Drowning in a mountain of debt? Trust me, I’ve been there. And a personal loan saved me a lot of money on interest. When someone has a lot of credit cards and/or loans, it can be difficult to keep up with the various due dates and minimum payments.

I can barely remember to eat lunch some days and am not one for spreadsheets, so a personal loan was a great option to consolidate debt payments into one payment.

The single payment is often much smaller than all of the little payments added together, so not only does it make it easier to pay, it can save people a lot of money in the long run on interest, especially if they have a lot of high-interest debt. This is a particularly good option for those with good credit because the new loan should have a lower interest rate.

Pro-Tip

People often use personal loans to consolidate credit card debt and then continue to add transactions to their credit card balances. This can cause a heap of trouble and put someone in a serious financial bind.

Take my advice – if you get a debt consolidation loan, do not wrack up credit card debt again. I have seen this cycle happen it it always causes the borrower a lot of stress.

Improve Credit Score

Ah, the dreaded credit score. This 3-digit number is so important when it comes to borrowing power. The lowest credit score a person can have is 300, and the highest is 850. There are a lot of things that can affect your credit, and it can be a difficult and long journey to improve it. While a personal loan is not always the best way to improve credit, there are situations where it is a great idea.

If a borrower has several different credit cards and all of those credit cards are near their limit, it can negatively affect their credit. That’s right. Creditors give out credit limits like candy, but they don’t want people to use their entire credit limits. The ratio of credit limit to credit usage is known as credit utilization, and if this ratio is high, it makes a credit score go down.

If this is the reason your credit score is decreasing, a personal loan can be a great option. Getting a personal loan to pay off those credit cards opens up room on those credit cards and decreases credit utilization, which in turn can improve your credit. 

See Related: Best Credit Union Solar Loans

Establish Credit

People who have never gotten a loan or credit card do not have credit. Unfortunately, people need credit scores to get approved for home and apartment rentals, automotive loans, and even to set up power service in their name. Not having credit can definitely hold a person back, so it is important to establish credit.

Getting a small personal loan can be a great way to establish credit. If a person hasn’t established credit yet, their interest rate may be a little higher than someone with established credit with a high credit score.

However, with a small loan amount, the payments should be manageable, and making on-time payments on a personal loan can help quickly establish credit and shoot your score toward the higher end of the range. 

Home Improvements and Renovations

I love watching home improvement shows. Like, I LOVE them. Unfortunately, they give me a ton of ideas for my home that would cause my bank account to laugh at if it was alive. Luckily, a personal loan can be a great option when someone wants to make home improvements.

For years, I stared at this wall in my kitchen with growing hatred. I wanted it gone. I wanted an open-concept kitchen, so I could wave at guests in my living room while whipping up some tasty treats. I just couldn’t swing it financially out of pocket. 

I decided to get a personal loan to pay someone to knock that wall down, and I kissed that annoying wall goodbye. 

For those looking to make changes in their homes without paying for it all upfront, a personal loan is a great way to make the improvements and pay for them over time. Do your research to find the most economical personal loan for these home improvement projects

Large Purchases

Home renovations aren’t the only large purchases we make. Weddings, dream vacations, and elective surgeries are just a few examples of large purchases people make on a regular basis. All of these things cost a lot of money that many people (like me!) don’t have in their bank accounts.

A personal loan can be a great way to plan that dream wedding or jet set off to Cabo. Elective surgeries are not covered by insurance, but many people want them to look better and improve confidence. These costly surgeries can also be covered by a personal loan. 

See Related: Best Immigrant Loans for Small Business

Times a Personal Loan May Not Be the Best Option

Loans may not always be a good idea. There are a few cons of personal loans that could make them a bad option for some. Here are a few situations in which a personal loan may not work.

Really Low Credit Score

While taking out a personal loan can be helpful in building credit, it may not be the best option for those with extremely low credit ratings. The lower the credit score, the higher the interest rate.

This means that someone with a really low credit score would end up spending exponentially more than the original loan amount, and the monthly payments would likely be sky-high. If a borrower can afford this, then it may still work, but if it would put even more financial strain on their lives, they may want to avoid loans until their credit has improved a bit more. 

If you decide your credit is too low for applying for personal loans, check out the credit building credit card at Chime. This is a great program that allows users to put a deposit on the card and use it for purchases and make monthly payments to build credit. Chime reports to all three of the major credit bureaus. This is a great option to build credit to prepare for getting lower-interest personal loans in the future. 

If the Payment is Not Within Your Budget

A personal loan can be a great way to consolidate debt or make a large purchase, but the loan amounts and monthly payments are something important to consider. When taking out a personal loan, it is crucial to weigh whether the monthly payment fits your budget. If you can’t afford it or if it would be cutting it close to adding it to your list of bills, a personal loan may not be the best option for you. 

See Related: How to Finance Solar Panels: Loans & Other Options

How Does a Personal Loan Affect Credit Score?

How Does a Personal Loan Affect Credit Score? Graphics

I covered how personal loans can help improve a credit score above but wanted to elaborate a bit more on how personal loans can affect your credit. A personal loan can both negatively and positively affect a borrower’s credit. Here are a few things to consider regarding a personal loan and your credit.

Credit May Decrease Temporarily

One thing to know is that when a person is taking out a personal loan, their credit may initially take a negative hit. This often happens when a lender runs your credit and when a borrower takes on additional debt. This decrease is only temporary, but it does affect borrowing power.

It is not recommended to attempt to get more than one major loan back-to-back. For example, if a borrower takes out a large personal loan for a home renovation but then tries to apply for a car loan, the second loan may not be approved. That’s because, to lenders, the borrower may seem like they have as much debt as they can manage. 

Making On-Time Payments is Crucial

Set up automatic payments. Set a reminder on your phone. Do anything to ensure the payments for your personal loan are made on time. This can help increase any negative impact on your credit the loan initially caused as well as build credit history on your credit report, which makes up 35% of your credit score.

Keeping your payment history positive can improve your credit and improve your chances of receiving more personal loan funds in the future. 

See Related: Solar Loan Calculator: Determine the Cost of Financing

Things to Consider Before Taking Out a Personal Loan

Things to Consider Before Taking Out a Personal Loan Graphics

Interest Rate

Not all personal loans are created equal. Interest rates can range from low to outrageously high. When taking out a personal loan, it is important to take a look at the personal loan interest rates.

These interest charges usually correlate with the potential borrower’s credit rating, but getting the best interest rate possible for your credit is the way to go. A lower interest rate can help a borrower pay off personal loans more quickly. 

Assess Additional Costs

Interest rates aren’t the only costs associated with personal loans. Additional costs can include origination fees, late payment fees, and prepayment penalties. Origination fees are charged by the lender for processing the loan application.

Late payment fees can add up if you make late payments regularly. Prepayment penalties are fees the borrower pays if they pay the loan off early. All of these costs can add up if you aren’t careful. 

Personal Budget

Don’t bite off more than you can chew. This saying works for many aspects of life, but it is especially true in financial situations. When looking for a personal loan, plan a budget and stick with it.

Don’t get personal loans that have loan payments so high that you won’t be able to make a regular on-time monthly payment. It is always best to avoid unnecessary debt, so if you don’t really need the loan, it may be better to wait.

Check the Fine Print

Get those reading glasses out if needed, but please, please, please check the fine print on any loan documents. One important thing that can be hidden in the fine print is a floating interest rate. This is a sneaky tactic that gives you an initial lower interest rate, but it slowly increases over time.

This can really put a borrower in a bind later, so it is crucial to read the fine print before signing any personal loan documents. Know what you are getting yourself into, and don’t be afraid to ask questions.

See Related: Best Green Personal Loans to Consider Today

Is the Lender Reliable?

One of the cons of personal loans is the fact there are some seriously unreliable lenders out there. Those sneaky fine print issues are usually tactics used by unreliable lenders. Before agreeing to accept a loan from a lender, do some research. Check out online reviews and see if they have any shady practices.

Check the Better Business Bureau for complaints. Do your due diligence to figure out if the lender is someone you can trust. An unreliable lender can cost a borrower a lot of extra money and negatively impact their credit. Luckily, there are a lot of reliable lenders out there. 

Secured Personal Loan vs. Unsecured Personal Loan

Most personal loans are placed into two categories: secured and unsecured. A secured loan is backed by collateral. This means that the borrower agrees to allow the bank to take something they own, such as a car if the borrower doesn’t make the agreed-upon payments. Unsecured personal loans do not require the borrower to use assets as collateral.

Secured personal loans are usually reserved for people with lower credit ratings. It is important to decide whether or not you are open to secured loans before researching loans. Secured loans can provide more options for those with poor credit and can give the borrower lower monthly payments and a more reasonable interest rate than an unsecured loan.

Choosing the Right Personal Loan

Personal loans work as an affordable way to borrow money, but choosing the right lender can feel overwhelming. Before visiting a lender’s site, it is helpful to know the loan amount needed and your budget for loan payments. An expert personal loans lender like Axos or Lending Tree can help guide borrowers through the process of getting personal loans and make finding the right loan easy. 

Axos has personal loans for debt consolidation, home improvement, and major purchases of up to $50,000 for three to six years. Their rates are fixed, so you don’t have to worry about those pesky floating interest rates that sneak up on you. There is an easy online application process that you can check out here

Lending Tree is a well-known personal loan lender that offers interest rates as low as 5.99%. They have loans for consolidating debt as well as personal loans that can be used for home improvements and other large purchases.

Lending Tree’s website is very user-friendly and has a handy payment calculator as well as a way to compare rates on various loan options. Their expert team is on hand to answer any questions and help make the process smooth. Lending Tree’s competitive rates and fixed monthly payments make them a great option for those considering online lenders.

These are two great lender options, but there are multiple lenders out there. Some lenders are great for those with good credit, while others are better for borrowers with less-than-ideal credit. Don’t be afraid to take your time, compare rates, and ask questions before agreeing to do business with a lender.

A loan is a years-long commitment, and while it is a great option for many things, it shouldn’t be taken lightly. Taking out a personal loan is not always a bad idea. They can help build a strong credit score, pay off medical debt, consolidate high-interest debts into one lump sum, improve someone’s financial situation and save money, and more. Just be sure the interest rate, monthly payment, and fine print suit your needs.

Related Resources

Leave a Comment