If you need extra cash to cover a large purchase, pay for home improvements, finance a wedding, or consolidate high-interest debt, you might want to consider a personal loan. Used wisely, a personal loan can help cover gaps in your budget without putting your home or other assets at risk.
As with other loans, interest rates for personal loans hinge on various aspects of your financial portfolio, including your credit score, payment history, and debt-to-income ratio. That means they’re not the right choice for everyone. But if you have some savings and decent money habits, a personal loan could be a valuable tool for getting your debts under control and reaching your other financial goals.
Should I get a personal loan? Key takeaways:
You can use a personal loan for almost any purpose, including debt consolidation, home improvements, and emergency expenses.
Personal loans typically have lower interest rates than most credit cards.
Applicants with high credit scores and low debt often get the lowest rates.
It’s important to have a clear repayment strategy any time you take out a personal loan.
How do personal loans work?
Personal loans are a type of credit issued by a bank, credit union, online lender, or other financial institution. Unlike mortgage loans or car loans, personal loans can be used for a wide variety of purposes. They’re considered installment loans, which means that if you’re approved, you’ll receive the loan in a single lump sum. You’ll then pay that money back (with interest) in monthly payments, or “installments,” over the life of the loan.
Once you pay off your personal loan in full, your account will be closed. This makes personal loans different from credit cards, which are a type of revolving credit. If you pay off a credit card but need to make another purchase, you can just use the card again. If you pay off a personal loan but need more money, you’ll have to apply for a brand-new personal loan.
There are two types of personal loans: secured and unsecured.
Unsecured personal loans don’t require collateral. Rather, the lender decides whether or not you qualify based on your financial history and credit score. If you don’t qualify for an unsecured loan or want a lower interest rate, some lenders also offer secured loans.
Secured personal loans are backed by collateral, like a savings account or certificate of deposit (CD). If you don’t repay your secured loan on time, the lender could seize your asset as payment. This makes secured loans riskier for the borrower but less risky for the lender. For that reason, lenders typically offer lower interest rates for secured loans than they do for unsecured loans.
When a personal loan makes sense
A personal loan makes sense when all four of the following are true:
You need cash for a specific, necessary expense — like remodeling a house or paying off high-interest credit cards.
You need the cash now.
Some debt is unavoidable.
It’s less expensive than other forms of credit.
Here’s a breakdown of some common situations that necessitate personal loans. Take a look through each example to help you further evaluate whether or not a personal loan makes sense for you.
High-interest debt refinancing
You can use a personal loan to do a DIY refinance of high-interest debts. Here’s how it works: you take a personal loan at a low or moderate interest rate, then use that cash to pay off your credit cards or other debts. When that’s done, you only have to worry about paying off your lower-interest-rate personal loan.
Personal loans are a good choice for refinancing because they typically have lower interest rates than short-term loans like title loans or payday loans. They’re also much less expensive to pay off than most credit card debt. As of Aug 2022, the average personal loan interest rate was 10.16%, while the average credit card rate was 18.43%. With that kind of difference, a personal loan could help you save a ton of money in interest charges.
For example, say you’re a borrower with good credit. You have two credit cards with a total balance of $30,000 and a combined interest rate of 18%. Right now, you pay $500 toward each card every month. However, if you refinance these debts by taking out a single personal loan with a 10% interest rate and a three-year term, you could save almost $4,000 over that time frame. You’ll also have a lower monthly payment and get out of debt faster.
Personal loans are also a better choice for debt refinancing than balance transfer cards. They’re typically processed more quickly than balance transfers, and they usually offer lower interest rates than you’ll find on most balance transfer cards. (Some balance transfer cards offer enticing, low-interest-rate introductory offers, but these usually end after a year, which could leave you with higher interest charges than you started with.)
Debt consolidation
If you’re in a situation where you owe lots of different lenders, a personal loan can help you consolidate that debt, i.e., combine all your outstanding balances into one single bill. You can take out a personal loan, pay off your outstanding credit cards, and then make a single, simple payment to your new personal loan servicer each month. That makes your debt easier to manage, which could help you avoid accidental late fees and unnecessary interest charges.
Emergency expenses
If you need money right away and you don’t have an emergency fund available, personal loans could be a good option. They have a faster approval process than other types of loans, and they’re safer than title loans or payday loans, which are issued quickly but can have interest rates approaching 400%, per the Consumer Financial Protection Bureau.
Many personal loan lenders offer same-day or next-day funding. Others will deposit the loan amount in your bank account within a few business days. Often, it’s better to wait the extra day or two to receive the funds than risk an expensive title or payday loan.
When other types of loans won’t cover your expense
Some loans are created for specific purposes, like student loans, mortgage loans, and auto loans. Personal loans, however, are very flexible. When another type of loan won’t cover your costs at a better rate, a personal loan is a viable option. Some common uses include:
Home improvement or home repairs
Whether it’s a renovation or repair, home improvement is a common reason to take out a personal loan, particularly if the project adds value to your home. However, you may want to look into Home Equity Lines of Credit (HELOC) first to see if you can get a better deal.
Weddings and funerals
Some people take out personal loans to cover unexpected expenses like weddings or funerals. If you have a stable income and a watertight plan to pay the loan back, this can be a good way to cover big upfront costs.
Vehicle financing
Auto loans are available if you’re looking to buy or lease a car, but personal loans could help you cover any gaps. Auto loans tend to have lower interest rates compared to personal loans, but they are secured loans that use your vehicle as collateral. If you’re worried about missing payments and your car getting repossessed, a personal loan might be a better option for you.
Moving costs
If you’re moving out of state, you may need extra cash to cover moving expenses. These can include the costs of packing, hiring movers, and transporting your belongings.
Large purchases
If your refrigerator breaks or you need to replace the engine in your car, a personal loan can provide relief. But before you use a personal loan for a big expense, do a little math to make sure taking out the loan will actually save you money in the long run. If an emergency car repair will help you save on rental car and ride-share costs, for example, it might be worth taking out a personal loan to cover it, even despite the loan’s interest charges and fees.
When a personal loan doesn’t make sense
While personal loans can be a saving grace in times of need, they might not always fit your personal finance goals. Avoid a personal loan when:
You can’t afford it
Remember, you’ll still need to pay this loan back. If you can’t afford the monthly payments for a new personal loan, try to avoid borrowing money if at all possible.
You don’t really need it
If you’re trying to cover a discretionary or “nice to have” expense like an extravagant vacation, expensive home remodel, or over-the-top wedding, reconsider. Try scaling your budget back or putting off these expenses until you have more cash on hand.
You have bad credit
When you apply for a personal loan, the lender will check your credit history to assess your creditworthiness. If you have poor credit, the lender might only be able to offer you a high interest rate. You may still qualify for a secured personal loan, but you’ll have to offer up collateral that the lender can claim if you don’t repay your loan on time. This collateral can include your car, home, or savings account. In these cases, it’s best to avoid taking out a personal loan.
You’re paying off medical bills
Personal loans are rarely the best option for paying off medical bills. Instead, try one of these low- or no-interest methods.
Payment plans: Ask your doctor’s office if you can set up a payment plan that splits a large bill into smaller monthly payments.
Medical bill advocates: Medical bill advocates negotiate down bills after an expensive procedure or hospital stay. They can also identify and dispute costly errors.
Medical credit card: Some doctor’s offices offer medical credit cards that have interest-free promotional periods. If you’re confident you can pay off the expense within that promotional period, these may be worth considering.
There is a loan type dedicated to your expense
Student loans, mortgages, home equity lines of credit (HELOC), and auto loans all offer better repayment terms than personal loans if you’re using them for their intended purposes. For example, if you’re hoping to pay for a home remodel, a HELOC might be the way to go (though this is a type of secured loan and therefore comes with some risk). If you’re hoping to refinance your student loans, you should first consider the many purpose-made loans to reduce your student loan payments, and consider a personal loan a last resort.
You intend to continue adding to your debt
Some borrowers use a personal loan to pay off their credit card debt — only to continue spending recklessly afterward. It’s important to understand you will not be debt-free after using a personal loan to refinance; your debt will only be more manageable. Any time you take out a loan, make sure you have a clear, detailed plan for paying it off. If you don’t, it may be best to avoid taking out a personal loan at this time.
Personal loan FAQs
Ask yourself these questions to ensure you’re prepared for your new personal loan.
How will a personal loan affect my credit score?
When you apply for a loan, the lender will pull your credit report as part of the application process. This is known as a “hard inquiry,” and most credit bureaus will see it as a potential sign that you’re low on funds. As such, hard credit inquiries will usually lower your credit score by a few points.
Hard inquiries stay on your credit reports for about two years. Consider checking your rates with lenders that conduct “soft inquiries,” which won’t impact your scores.
The good news is that if you decide to take out a personal loan and then make a series of on-time payments, this demonstrates responsible financial behavior. Over time, it can actually boost your credit score and improve your credit.
What credit score do I need to get a personal loan?
Credit score requirements for personal loans vary by lender. Many give preference to borrowers with good or excellent credit scores (690 and above). With a FICO score above 760, you may qualify for annual percentage rates (APR) as low as 3.99%.
That said, you can get decent rates with a much lower score. The minimum credit score to qualify for a personal loan is usually 560 to 660. If your score is below this range, you may be able to apply with a cosigner to increase your likelihood of approval. You can use the Navient Marketplace to find options for virtually any credit score.
Do personal loans have high fees?
Some lenders charge a fee to cover the cost of processing the loan. Origination fees typically range from 1 to 6% of the loan amount. Lenders also often charge fees for late payments and bounced checks or account withdrawals. You may also face prepayment penalties if you repay your loan before the loan term is up. Most lenders will have all their fees clearly listed either online or in the contract so you can review them before you sign.
How soon will I get funds from a personal loan?
Personal loan disbursal times vary by lender. Some online lenders provide funds as quickly as the next day. With others, you’ll have to wait one to five business days before the money hits your account.
What are some alternatives to a personal loan?
Before you take out a personal loan, consider these potential alternatives.