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Exploring the Pros and Cons of Personal Loans

By Austin Kilham · September 29, 2022 · 5 minute read

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Exploring the Pros and Cons of Personal Loans

A personal loan is a strong option when you need to borrow money to cover a medical bill or home repair, or to consolidate debt. But before you decide that a personal loan will meet your needs, it’s important to understand the advantages and disadvantages that come along with them.

We’ll do a deep dive into interest rates, borrowing limits, fees and penalties, and lender requirements to get the best terms.

What Are Personal Loans?

A personal loan is money that you borrow from a bank, credit union, or online lender. It’s an installment loan, so you agree to repay the loan principal and interest at regular intervals — usually monthly.

When you apply for a personal loan, your lender will run a credit check, which will help determine your interest rate. Generally speaking, borrowers with higher credit scores have a better chance of being offered lower interest rates. The higher your interest rate, the more money it will cost you to borrow.

Recommended: 11 Types of Personal Loans

The Benefits of Personal Loans

Personal loans are a flexible option for borrowers looking to accomplish a variety of goals, from consolidating other debts to remodeling their home. Here’s a look at some of the advantages.

Comparatively Low Interest Rates

Personal loans offer relatively low interest rates when compared to other methods of short-term borrowing. The average personal loan interest rate is 9.41% according to the St. Louis Federal Reserve. Credit cards by comparison have average interest rates of 14.56% and up, and a personal line of credit can have interest rates that vary between 9.30% and 17.55%.

Some forms of predatory short-term lending, such as payday loans , can charge the equivalent of many times these rates to borrow.

Average Interest Rates

Personal Loans 9.41%
Credit Card 14.56%
Personal Line of Credit 9.30% – 17.55%

Comparatively High Borrowing Limits

Small personal loans are usually for amounts of $3,000 or less. (Smaller loans often come with lower interest rates.) However, some lenders will offer loans of up to $100,000 to cover major expenses and life events, which may be quite a bit more than other credit options.

The average credit limit for credit cards, by comparison, is $30,365, according to credit reporting bureau Experian. Personal lines of credit have a range of limits from $1,000 to $100,000, similar to the range offered by personal loans.

Borrowing Limits

Personal Loans Up to $100,000
Credit Card Average limit of $30,365
Personal Line of Credit Up to $100,000

Personal Loans Can Be Used for Many Things

Some types of loans must be used for designated purposes. Auto loans must be used to buy a car, and a mortgage must be used to finance a house. Personal loans, on the other hand, have few restrictions on how you must use the money, and you can generally use it for any purpose.

Recommended: Common Uses for a Personal Loan

No Collateral Necessary

Unsecured personal loans are the most common type of personal loans. They are not backed by collateral, such as your car or home.

Some personal loans are secured, and require you to borrow against the equity in your personal assets, like a home or your savings. With a secured vs. unsecured personal loan, the lender can seize your property if you default, selling it to recoup their loss. As a result, secured loans present less risk for the lender and often come with lower interest rates than unsecured loans.

Simple to Manage

You can use personal loans to consolidate other, higher-interest debt, for example, by paying off the balance on several high-interest credit cards. A single personal loan can offer cheaper interest, lowering the cost of your debt over time. And it may be easier to manage, since you only have one bill to pay each month.

Can Help Building Credit

Your lender will likely report your personal loan and payment history to the three credit reporting bureaus — Experian, TransUnion, and Equifax. In fact, 35% of your FICO® score — the most commonly used credit score — is determined by your payment history. You can build up a strong credit history over time merely by avoiding late or missed payments.

The Disadvantages of Personal Loans

Without properly weighing the potential disadvantages, personal loans can be a bad idea for some borrowers.

Higher Interest Rates Than Some Alternatives

Personal loans may carry higher interest rates than some alternatives. For example, if you’re looking to remodel your home, you might consider taking out a home equity loan or a home equity line of credit (HELOC).

A home equity loan uses your home as collateral. As of June 2022, the average interest rate on a 10-year fixed home equity loan was 6.02%. A home equity line of credit, is a revolving credit line that uses your home as collateral. Borrowers with good credit can qualify for interest rates ranging from 3% to 5%. Those with below-average credit are likely to receive interest rates that range from 9% to 10%.

Fees and Penalties

Some lenders may charge fees and penalties in association with personal loans. For instance, an origination fee helps pay for the processing of your loan application and is usually equal to a percentage of the loan amount. Fortunately, it’s possible to avoid origination fees.

Lenders may also charge prepayment penalties if you pay off your loan ahead of schedule, to make up for profit they are losing on interest payments.

Can Increase Debt

Take out a personal loan only if you are sure you can pay it off and it makes financial sense. For example, a home remodel could increase the value of your home, and consolidating credit card debt could save you money in interest payments.

Avoid taking out a loan that is for more money than you need to avoid the risk of taking on more debt than necessary.

Alternatives to Personal Loans

In addition to personal loans, you may wish to explore other forms of credit that can help you finance big and small expenses.

•  Credit cards allow users to make purchases using credit, which they pay back at the end of each billing cycle. Borrowers must make minimum payments and owe interest on any balance they carry from month to month.

•  A personal line of credit (PLOC) is similar to a credit card. It allows you to tap your credit line as needed. Credit is replenished when you pay back your loan.

•  A home equity loan uses a borrower’s home as collateral. The value of the property determines the loan amount.

•  A home equity line of credit is a revolving source of credit, like credit cards and PLOCs. As with home equity loans, HELOCs use the borrower’s home as collateral.

Exploring Personal Loans Further

A personal loan is a type of installment loan, usually unsecured, that allows you to use the money for a variety of unexpected expenses. Borrowers with higher credit scores have a better chance of being offered lower interest rates. This is important because the higher your interest rate, the more money it will cost you to borrow. Also, some lenders charge extra fees and penalties.

If you’ve explored your options and decide that a personal loan is right for you, it’s wise to shop around to find the right loan. Consider personal loans from SoFi, which offers loans of up to $100,000 with no fees. Check SoFi personal loan rates and your own personal loan rate. Borrowers may receive funding as quickly as the same day it is approved.

Compared with high-interest credit cards, a SoFi Personal Loan is simply better debt.

FAQ

What is a personal loan?

A personal loan is a loan you receive from a bank, credit union, or online lender. Borrowers pay back the principal and interest in regular installments.

What can you use a personal loan for?

Personal loans have few usage restrictions. You can use them for everything from covering an unexpected medical bill to remodeling your kitchen.

How much money can you get from a personal loan?

Personal loan amounts may range from a few hundred dollars up to $100,000 from some lenders.

Photo credit: iStock/Anchiy
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