Key takeaways
- A personal loan can get you cash within days at a fixed rate and steady payment.
- Personal loans tend to carry lower, more affordable interest rates than credit cards.
- Before deciding to get a personal loan, consider potential downsides, such as steep fees and rigid repayment terms
Personal loans can be a great tool to help streamline your budget or get money fast in an emergency. From debt consolidation to paying a big car repair bill, you can usually qualify with a good credit score and stable income. Many lenders even offer same-day funding, giving you access to funds quickly. Average rates are also typically lower than other forms of debt like credit cards, which could save you hundreds, if not thousands, in interest charges.
However, like all financial products, personal loans have drawbacks. Some lenders charge high fees, and the monthly payment may be steep if you only qualify for a short repayment term. Before you take one out, it’s worth weighing the pros against the cons to determine whether a personal loan is the right financing option for you.
Pros and cons of personal loans
Pros
- One lump sum. You’ll receive all of your loan funds at once.
- Fast funding time. Loan funds may be available the same day you apply.
- No collateral requirement. Doesn’t tie up equity in a car or home to qualify.
- Lower interest rates. You’ll typically pay lower rates than you find on credit cards.
- Flexibility and versatility. Funds can be used for a variety of purposes.
- Fixed rate and payment schedule. You’ll have a set payment with a definite end date.
- Could boost your credit score. Replacing revolving credit card debt with fixed personal loan debt could improve your score.
Cons
- Interest rates can be higher than alternatives. Bad credit rates can exceed 36 percent.
- No payment flexibility. No minimum payment options like you have with a credit card.
- Fees and penalties can be high. Fees of 10 percent or more may be deducted from your loan funds.
- Shorter repayment terms than other options. The five-year maximum term offered by most lenders could make the payment very high compared to home equity loans.
- Increased debt load. You could have trouble getting other loans because of a high personal loan payment.
- Credit can’t be used again as you pay it off. Because personal loans are installment loans, you can’t re-use credit as you pay it off like you can with a credit card or other revolving lines of credit.
- Potential credit damage. The lender will do a hard inquiry credit check to finalize your loan terms, temporarily reducing your credit score.
Advantages of personal loans
Below are a few advantages of using personal loans over other types of loans. Knowing them will help you determine if this type of financing is the best choice for your borrowing needs.
One lump sum
Getting your entire loan at once makes it easier to fund everything from major home renovation projects to major life events like weddings. Since the amount is paid back in installments at a fixed rate, you have a predictable monthly payment that won’t change for the life of the loan.
That gives you much more stability than credit card rates, which are often variable. And since you can’t re-use the credit as you pay it off, there’s no risk of carrying a balance like you have with a credit card.
Fast funding times
Many personal loan companies offer fast approval and funding timelines, giving you access to funds usually within one business day. That makes them useful for emergencies or other situations where you need money quickly. Some lenders can deposit the loan proceeds into your bank account the same day you apply if you qualify.
No collateral requirement
Personal loans are unsecured, so you don’t need collateral like a car or home to get approved. If you’re unable to repay the loan, your credit score could be damaged, but because it’s not secured, you won’t risk losing your transportation or shelter from a bank repossession or foreclosure.
Lenders typically approve you based on proof of stable employment, regular earnings and your credit score. Since the lender doesn’t have to evaluate the value of any collateral to lend you money, the process is often faster than a secured loan.
Lower interest rates
Personal loans often come with lower interest rates than credit cards. As of September 2024, the average personal loan rate is 12.42 percent, while the average credit card rate is 20.78 percent.
Borrowers with excellent credit scores can qualify for average personal loan rates of around 10.73 percent to 12.50 percent. You may also qualify for a higher loan amount than the limit on your credit cards.
Bankrate tip
You can avoid paying interest on your credit card by paying off the balance during the grace period. However, if you regularly carry a balance, paying it off with a personal loan is generally a cheaper alternative.
Flexibility and versatility
Personal loans can be used for many purposes, such as paying for home improvements, buying an expensive vehicle like a boat or recreational vehicle or consolidating multiple debts into one easy-to-track payment.
You’re not limited to specific uses like you are with a car loan, which can only be used to buy a vehicle. Some lenders offer loan amounts as high as $100,000, giving you much more borrowing power than most credit card companies allow.
Bankrate tip
Despite the overall flexibility to use your funds as you wish, there are some limits. Personal loan money generally cannot be used for college tuition and other post-high school education expenses, investing and anything illegal.
Fixed rate and payment schedule
Unlike credit cards, you’ll know exactly how much you’ll pay each month, the interest rate you’ll pay and how many months or years it will take to pay it off. Your rate will stay the same since it’s fixed, reducing the stress you may encounter if you carry variable-rate credit card balances.
You can also repay the loan over terms as long as seven years, giving you breathing room in your budget. However, most personal loans allow you to pay the balance off early without any penalty if you want to. Remember: The longer your loan term, the more interest you’ll pay over the life of the loan.
Could boost your credit scores
Many people use personal loans to consolidate debt, especially revolving debt like credit cards. The reason is simple: Paying off credit cards is a great way to improve your credit utilization ratio which plays a major role in how high — or low — your credit score is.
It could also reduce the risk that you end up with a late payment trying to manage several variable-rate credit card payments each month by replacing them with one fixed-rate personal loan payment.
Disadvantages of personal loans
A personal loan isn’t the right financial move for every situation. Learn the cons so you don’t get in over your head with a regular fixed payment that your budget can’t handle.
Interest rates can be higher than home equity alternatives
If you own a home, you may want to compare a home equity loan or home equity line of credit (HELOC), especially if your credit scores are fair or good. This is especially true for borrowers with poor credit who may see rates north of 30 percent, higher than many credit cards.
Bankrate tip
Some lenders offer secured personal loans at lower rates than you can get with an unsecured loan. Just remember you could lose the asset if you can’t pay the loan back.
No payment flexibility
Once you choose your loan amount and repayment term, you’re locked into that payment until the repayment period is over. If your payment varies (tip income or self-employment), you may want to stick with a credit card, since your payment is only based on what you use and you have a minimum payment option.
If you don’t need all the funds at once, you may want to check out a personal line of credit or home equity line of credit. You can use the funds as you need them, pay the balance off and re-use the line of credit as needed.
Fees and penalties may be high
Personal loan lender origination fees can range from 1 percent to 12 percent of the loan amount. The fees are generally subtracted from the amount disbursed to the borrower.
Although rare, some lenders charge prepayment penalties if you pay the balance off before the end of your loan term. Before applying, review all fees and penalties of any personal loans you are considering.
Bankrate tip
When choosing your final loan amount, account for fees. They will be deducted from the amount you borrow. Once you sign on the dotted line, you’ll have to start over with a new loan to get any additional funds.
Shorter repayment terms than other options
One drawback to personal loans versus home equity loans is repayment terms are generally capped at seven years. You can choose terms as long as 30 years on a home equity loan, HELOC or cash-out refinance, which will give you a much lower monthly payment.
There are also tax advantages to using home equity loans instead of personal loans if the funds are exclusively for home upgrades or renovations. The interest on a mortgage used for renovations may be tax-deductible, while that’s not the case if you take out a personal loan for home improvement.
Increased debt load
Many lenders set a maximum payment period of five years, which could result in a monthly payment that significantly increases your debt-to-income (DTI) ratio. Lenders measure your DTI ratio by dividing your total debt by your before-tax income. A high DTI ratio may make it difficult to borrow money in the future.
Repeatedly using personal loans to consolidate credit card debt may indicate that you rely too much on credit use. If you’re not careful, it can be tempting to rack up more debt after you pay it off with a debt consolidation loan rather than focusing solely on paying it off.
Taking out a personal loan can help you consolidate high-interest debt. It can also cause you to go deeper into debt if you don’t address bad money habits like spending without a budget, not saving enough or impulse spending.
Credit can’t be re-used as it’s paid off
Personal loans require you to receive all your money at once and make payments on the entire balance. Credit cards allow you to use as much or as little of your approved credit as you want and re-use it in the future.
Even if you don’t need all the personal loan money right away, you immediately start making payments on the entire balance. Your credit card payment, on the other hand, is only based on the charged amount, not your entire credit limit.
Potential credit damage
When you apply for a loan the lender will conduct a hard credit inquiry, which will knock your score down a few points. However, the initial dip doesn’t last long and the short-term dip due to the inquiry may be more than offset by a reduction in your credit utilization ratio, especially if you’re paying off piles of credit card debt.
Remember: The amount of revolving debt you owe makes up 30 percent of your FICO Score, so if you consolidate your debt and reign in any future credit card use, your scores could rise substantially.
Should I get a personal loan?
Personal loans are an attractive option, especially if you need quick cash.
The author’s expert insight
“A personal loan is a good choice if you have room in your budget for a fixed payment for two to seven years and a steady, reliable income. It’s a great tool for consolidating credit card debt, as long as you don’t charge the cards up later. You’ll want to avoid personal loans if your income is unstable or you need payment flexibility (like you have with credit card minimum payments).”
— Denny Ceizyk, Bankrate senior loans writer
When a personal loan might be right for you
Once you’ve investigated the options available to you and your potential rates, here’s how to discern whether a personal loan might make sense for your situation:
- You have a strong credit score: The lowest interest rates are reserved for borrowers who have good credit.
- You make a steady paycheck: A personal loan only makes sense if you have a regular paycheck and make enough to comfortably make the payments for the term you choose.
- You want to pay off high-interest debt: Personal loans are a good way to consolidate and pay off costly credit card debt.
- You’ll use the funds toward necessary expenses: Other good reasons to use personal loans include paying for emergency expenses or remodeling your home.
When to look for an alternative
Personal loans are one of many ways to get cash. Personal loan alternatives might be a better fit for some circumstances.
- You have a habit of overspending: Paying your credit cards off with a personal loan may not make sense if you’ll immediately begin building up a new credit card balance.
- You can’t afford the monthly payments: Consider a personal loan’s repayment timeline and monthly payments. Use a loan calculator to determine whether or not you can afford the monthly payments for the term you’ll spend paying it off.
- You don’t need the money urgently: It might make sense to build up your savings to pay for a large purchase instead of taking out a personal loan and making payments with interest for many years.
- Your income or employment situation is shaky: Committing to a regular monthly payment for the next two to seven years doesn’t make sense if your paycheck or employment is inconsistent. Seasonal workers, commission employees and self-employed consumers may be better with the flexibility of a credit card or line of credit.
The bottom line
Personal loans have a lot of benefits for borrowers who need money quickly and prefer the security of a fixed rate and payment for the life of the loan. They may be a good “clean-up” tool if you’ve run up too much credit card debt or want to avoid borrowing against an asset like your home.
However, they can be expensive if you have bad credit and could quickly become a financial burden if your income isn’t predictable.
If you decide a personal loan is best, always compare interest rates and loan terms. Once you read the fine print, including fees and penalties, decide if the benefits of a personal loan outweigh the drawbacks before committing.
