Are Personal Loans Bad? What You Should Know Before Borrowing

Personal loans aren't bad if used responsibly. They can be a helpful source of financing for qualified borrowers, given they often carry lower interest rates than credit cards. Still, personal loans increase your debt, which does have some risks.

For example, if you can't honor your loan agreement, you may be charged additional fees and risk damaging your credit. You can also put your overall financial health in trouble if you're borrowing money just to make ends meet.

MoneyLion offers a service to help you find personal loan offers. Based on the information you provide, you can get matched with offers for up to $100,000 from our top providers. You can compare rates, terms, and fees from different lenders and choose the best offer for you.

When Is a Loan a Good?

If you're looking to finance a large purpose, here's why a personal loan can be the best choice:

1. Low Interest Rates for Qualified Borrowers

The latest Federal Reserve research puts the average interest rate on a 24-month personal bank loan at 11.57%, while the average credit card annual percentage rate (APR) runs much higher at 21.16%.

Borrowers with good-to-excellent credit can often qualify for a personal loan in the high single digits — somewhere between 7% to 9%. That's why personal loans are often used to combine and pay off high-interest credit card debt with debt consolidation.

2. Predictable Payments

Most personal loans have fixed interest rates, which means your APR stays the same throughout the loan.

You also can't increase the loan balance or spend beyond the original amount, so you'll know exactly how much you owe each month.

3. Potential Credit Score Increases

Being consistent and on-time with your personal loan payments will improve your payment history, which is the leading factor in determining your credit score.

Personal loans can also improve your credit mix, especially if you didn't have other types, like a credit card, before taking out the loan. Lenders like seeing that you can manage multiple different types of credit.

Risks of a Personal Loan

However, personal loans aren't the right choice for everybody.

1. High Interest Rates for Borrowers With Subpar Credit

Personal loans can have low APRs, but not everyone can qualify for the best terms. Plus, applicants with fair or poor credit who are approved will likely see APRs at the top end of the lender's spectrum, which can reach up to around 36%.

2. Extra Fees

Some personal loans charge an origination fee between 0.5% and 1% of the loan amount or prepayment penalties, which are around 2% of your balance.

3. Strains on Your Budget

A fixed monthly payment can be difficult to manage if your income is unstable or your financial situation changes unexpectedly. "Personal loans offer little flexibility in repayment since they are typically at a fixed interest rate for a fixed period of time," Sullivan said. "The payments are just like rent and utilities; they need to be made regularly."

4. Potential Credit Consequences

You can incur short-term credit score damage as a result of a personal loan, since the financing increases your outstanding debts, lowers your credit age and adds a hard inquiry to your credit report. If you mismanage the loan by skipping payments and accumulating late fees, you risk harming your long-term creditworthiness.

5. Can Encourage Unnecessary Spending

Unnecessary spending can create or worsen debt issues, and you want to ensure you're not using a personal loan as a bandage for bad spending habits.

"Borrowing money for any purchase that can't generate a return or at least result in savings greater than the cost of the loan is irresponsible," Sullivan said. "Consumers should recognize that they need help if they can't manage day-to-day financial affairs without borrowing."

Alternatives To Personal Loans To Consider

DIY Debt Repayment

If you're considering a personal loan for debt consolidation, see if you can pay down the debt using snowball or avalanche repayment methods.

0% Intro APR Credit Card

These cards offer a 0% APR for some time, usually 12 to 24 months, on new purchases and balance transfers. They're a good option for debt consolidation or financing a larger purchase if you can pay the balance off in the allotted time, as that allows you to avoid interest entirely.

Credit Counseling or Debt Management Plans

Credit counseling agencies provide free financial advice and, for a fee, will set up a debt management plan (DMP). DMPs consolidate debts into one monthly payment made to the credit counselor, who disburses the funds to your creditors as agreed. Ideally, the counselor has negotiated lower balances or interest rates.

Buy Now, Pay Later Plans

Buy Now, Pay Later (BNPL) programs offer short-term financing for select purchases, often at checkout. These programs generally let you skip or pay low interest, so long as you repay the loan on time. However, they sometimes carry extra fees and should only be used when absolutely necessary. In other words, don't let the financing offer entice you to buy something you don't need or ultimately can't afford.

Advance Savings

If you know a big purchase or expense is on the horizon, consider ramping up your savings to avoid borrowing funds. You can find ways to fund your emergency savings — launching a side hustle, selling gently used goods, and pausing or canceling monthly subscriptions, as examples.

How To Borrow a Personal Loan the Smart Way

1. Check your credit to get a better idea of what interest rates and terms you might qualify for. Keep in mind that lenders generally require very good to excellent credit, a FICO score of 740 or higher for their best advertised offers.

2. Borrow only what you need and can afford to repay. Otherwise, taking on a personal loan can lead to larger financial issues. Consider using an online calculator to determine estimated monthly payments based on APRs and repayment periods. Many lenders have these tools directly on their website.

3. Compare fees, terms and repayment timelines to find the best available offer for your credit profile. Consider pre qualification — a process in which the financial institution runs a soft credit check to determine approval odds, rate, and term estimates — to get a clearer comparison. Soft credit checks won't impact your credit score.

4. Have a solid repayment plan so you can avoid using the personal loan for any unnecessary spending. Plus, make sure you have a plan to make all payments on time, said Kyle Enright, president of lending at Achieve. Use tools like autopay to avoid undue damage to your credit score.

Ultimately, make sure that borrowing money supports your financial goals and doesn't set you back. Taking on debt isn't necessarily bad if you're using it in a way that benefits you.

FAQs

Are personal loans bad for your credit?

Personal loans can hurt your credit in the short term, as they increase your total debt level, lower the average age of your credit accounts, and put a new credit inquiry on your credit report. Missing payments on a personal loan also negatively affects your credit in the long term.

On the other hand, personal loans can ultimately enhance your payment history, credit mix and overall creditworthiness when managed correctly.

Will a personal loan solve my money problems?

Personal loans can sometimes be a good way to address pressing financial problems, such as high-interest credit card debt or unexpected home repairs, as they typically carry lower interest rates and have a more predictable repayment structure than other forms of financing.

However, debt is still debt, and failing to repay new outstanding balances as agreed can amplify a bad financial situation.

What is the biggest disadvantage of a personal loan?

Personal loans don't always provide affordable interest rates, as they vary by credit. Even if they do, you're still paying to borrow money. Plus, you're locked into making a monthly payment during the loan's term, and could risk missing a payment or, worse, defaulting if your financial situation changes.

How do I know if I can afford a personal loan?

Online personal loan calculators can help you estimate monthly payments based on the interest rate and terms you're eligible for. Getting prequalified can give you a better sense of your offers without hurting your credit score.

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