A personal loan can be a useful option when you need to borrow money to cover a medical bill, fund a home repair, or consolidate debt. This kind of loan can offer a considerable lump sum of cash at a relatively low interest rate, but you may need at least a good credit score to qualify and fees can be charged.
Before you decide that a personal loan is right for you, it’s important to understand the pros and cons that come along with them. Here, the information that can help you make a wise choice.
What Are Personal Loans?
What is known as a personal loan is money that you borrow from a bank, credit union, or online lender. Typically, it’s a lump sum amount you receive and, since it’s an installment loan, agree to repay the loan principal and interest at regular intervals — usually monthly.
The interest rate for a personal loan is likely to be fixed-rate, and the loan’s term is usually between two and seven years.
When you apply for a personal loan, your lender will run a hard 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.
With many lenders, you will need a FICO® credit score of at least 580 to qualify, and a higher score will probably allow you to get more favorable rates.
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 Rate
Personal loans offer relatively low interest rates when compared to other methods of short-term borrowing. The average personal loan interest rate is 12.38% as of August 2024.
Credit cards by comparison have average interest rates of 22.76% for accounts with balances as of May 2024 according to the Fed. A personal line of credit, which allows the borrower to withdraw funds up to a limit during the draw period, may have interest rates that vary between 9.30% and 17.55%, depending on credit score and other variables.
Some forms of predatory short-term lending, such as payday loans, can charge the equivalent of many times these rates to borrow. Some even have annual percentage rates (APRs) of 300% to 400%, so it can be wise to proceed with caution and see what lower-cost sources of funding may be available.
|
Average Interest Rates |
|
|
Personal Loans |
12.38% |
|
Credit Card |
22.76% |
|
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 large personal 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 $29,855, according to credit reporting bureau Experian®.
Personal lines of credit often have a range of limits from $1,000 to $50,000, which can be more than a credit card but less than a personal loan.
|
Borrowing Limits |
|
|
Personal Loans |
Up to $100,000 |
|
Credit Card |
Average limit of $29,855 |
|
Personal Line of Credit |
Up to $50,000 |
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 home. Personal loans, on the other hand, have few restrictions on how you must use the money, and you can generally use it for any legal purpose.
Popular uses for personal loans can include:
• Medical, dental, or car repair bills
• Home improvement projects
• Debt consolidation
• Travel
• Weddings or other major celebrations
• Holiday shopping
• Summer camp or other expenses for children
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, however, 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 collateral 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 less expensive 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 Be Quick to Obtain
Policies will vary, but some lenders may offer same-day approval and funding within just a few days.
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 help build a strong credit history over time by avoiding late or missed payments.
Recommended: Personal Loan Calculator
The Disadvantages of Personal Loans
These loans do have some downsides, which can potentially make personal loans a bad idea for some borrowers. Here’s a closer look.
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). Keeping in mind the current average interest rate of 12.38% for personal loans, consider the following:
• A home equity loan uses your home as collateral to offer you a lump sum of money to use. As of August 2024, the average interest rate on a 10-year fixed home equity loan was 8.62%
• A HELOC, on the other hand, is a form of revolving credit line that uses your home as collateral. You draw against your limit as needed during the draw period and, after a set number of years, enter the repayment period. As of August 2024, the average interest rate on a HELOC was 9.28%.
Also, your rate will likely vary depending on your credit score: The higher your score, the lower your interest rate may be.
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 if 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. But taking out a personal loan to fund a lavish wedding could wind up interfering with your ability to save for the down payment on a house.
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. 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 contributes to determining the loan amount that is transferred to the borrower as a lump sum.
• 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.
The Takeaway
A personal loan is a type of installment loan, usually unsecured, that allows you to obtain a lump sum of money, typically at a fixed interest rate and to be repaid in up to seven years. The pros of these loans can include their flexibility (you can use the money as you like), lower interest rates than some other sources of funding, and the speed, high limits, and convenience they offer. Among the cons: the possibility of having to pay fees and penalties and the fact that you might be able to get a lower rate with a secured loan elsewhere.
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.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
FAQ
What is a personal loan?
A personal loan is a loan you receive from a bank, credit union, or online lender and can use for a variety of purposes. Borrowers pay back the principal and interest in regular installments. These loans are typically unsecured (meaning collateral is not needed) and offer a lump sum payment, usually at a fixed rate of interest, with a term of up to seven years.
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 to paying for a vacation or consolidating credit card debt.
How much money can you get from a personal loan?
Personal loan amounts typically range from $1,000 to $100,000, though some lenders may offer lower or higher amounts.
Photo credit: iStock/Anchiy
SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .
Non affiliation: SoFi isn’t affiliated with any of the companies highlighted in this article.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
SOPL-Q324-044