Pros and Cons of Personal Loans: What You Should Know Before You Borrow

Personal loans are lump-sum installment loans commonly used to fund emergency expenses or consolidate high-interest debts. They have their upsides, including flexible borrowing limits, fixed repayment schedules and potentially low annual percentage rates (APRs). However, before you apply, it’s important to understand the pros and cons of personal loans to help you decide if applying for one is the right move.

Key Takeaways

• Personal loans offer flexible, fixed-schedule borrowing but come with trade-offs. They can provide predictable payments and potentially lower APRs than some credit cards, yet they still add to your debt load and may be expensive if your credit isn’t strong.

• The pros include clear structure, fast funding and wide use cases since many lenders offer quick approvals, lump-sum funding and terms you can use for debt consolidation, medical bills or other planned large expenses.

• The cons include higher rates for fair or poor credit, fees and overspending risk because origination charges, long repayment terms and using loans for nonessential or everyday expenses can increase your total cost and make it harder to get out of debt.

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Summary generated by AI, verified by MoneyLion editors

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.

What Are the Pros and Cons of Personal Loans?

Personal loans come in many different shapes and sizes and they all offer flexible use. However, oftentimes they only make sense if you can qualify for a competitive rate and commit to a consistent repayment plan.

When Is a Personal Loan a Good Idea?

Personal loans can be a good idea if their costs make sense for your situation. Take a look at some common personal loan benefits.

Debt Consolidation

Outstanding credit card balances are notoriously pricey. Plus, the ability to pay off and run up a balance again can create a cycle of debt for undisciplined spenders. People with high-interest credit card balances might consider a personal loan to consolidate debts and save on interest.

However, a personal loan is only your best option if you pay less over the life of the loan in interest than you would if you didn’t consolidate.

Emergency Expenses

A personal loan's lump sum can help you cover an unexpected emergency. You could also use it for a carefully planned expense if you have a clear payoff plan in place.

Planned Large Purchases

Personal loans can be a good choice when you’re looking to cover a large purchase and want a clear payoff date instead of carrying a credit card balance indefinitely. Examples can include home renovations to weddings.

When Is a Personal Loan a Bad Idea?

A personal loan is a bad idea if it would cause a financial burden or isn’t the proper solution for your financial issue.

Everyday Expenses

That's a sign of more deeply rooted financial issues and could warrant outside help. Non-profit credit counseling agencies can offer free advice or negotiate with your creditors to set up a debt management plan (DMP) for a fee.

Existing Debt Struggles

In this case, you may need to explore more extreme debt relief solutions, such as debt settlement or bankruptcy.

Poor Rates

Consumers with bad credit scores may find it difficult to get approved for a personal loan. While consumers with fair credit scores have a better chance. Having good to great credit will open up your options when it comes to finding personal loan offers and accessing better rates.

There are also many types of predatory personal loans that charge high APRs and can make it difficult for borrowers to break the cycle of debt. For this reason, it's best to avoid tribal loans and payday loans.

Unclear Repayment Plan

If you don’t have a clear repayment plan in mind, a personal loan isn’t a good idea. Consequences can include missed payments and credit score damage.

When Does a Personal Loan Actually Save You Money?

• When the APR is lower than your current debt

• When fees don’t outweigh interest savings

• When you're able to stop adding new debt after borrowing

• When payments fit comfortably within your budget

How Do You Get a Personal Loan?

Getting a personal loan is a straightforward process. Here are the basic steps:

1. Check your credit score

2. Compare the best banks and rates

3. Prequalify with a soft credit pull when available

4. Gather required documents such as proof of income

5. Submit your application

6. Get approved and receive funds

What Should You Watch Out for With Personal Loans?

Not all personal loans are the same. Here’s what to watch for:

• Taking on more debt than you can afford

• Origination fees and other charges

• High APRs if your credit score is lower

• Longer repayment terms that increase total cost of the loan

• Variable-rate loans

Is a Personal Loan Right for You?

Whether a personal loan makes sense depends on your needs and finances. Consider choosing a personal loan if you qualify for a lower rate than your current debt and if you need predictable monthly payments. However, it may be best to avoid one if you’re already struggling with debt or you can’t commit to a clear repayment plan. And remember, there's a difference between secured vs. unsecured loans, so make sure you have all the information before signing up.

FAQs

Is a personal loan a good idea?

A personal loan can be a good idea if you need the money for things like debt consolidation or emergency expenses. If you want money for nonessential spending, like a vacation or a shopping spree, it’s likely best to put money into savings until you meet your goal.

Do personal loans hurt your credit?

When you apply for a personal loan, the lender will initiate a hard inquiry, which can temporarily drop your credit score, though it's often a small dip and temporary if make consistent payments. But if you miss payments or fail to make them altogether, your credit score can drop dramatically.

Can you use a personal loan for rent or bills?

Although it’s not ideal, you can use a personal loan for rent or bills.

Are personal loans tax-deductible?

Personal loans are not tax-deductible, but the interest may be. If you used the funds for qualified business, educational or taxable investment expenses, it’s likely deductible.

Do personal loans have prepayment penalties?

It depends on the lender. Ask the lender if the loan includes prepayment penalties before signing on the dotted line. If so, it’s worth asking the lender to waive the penalties as a condition of you accepting the loan.

Key Terms

• Personal loan: A lump-sum installment loan you repay over a fixed term, often used for debt consolidation, medical bills or other large expenses.

• APR (annual percentage rate): The yearly cost of borrowing, expressed as a percentage, that includes interest and certain fees so you can compare loan offers.

• Debt consolidation: Using a new loan or credit product to pay off multiple existing debts, ideally at a lower overall rate and with a single monthly payment.

• Debt management plan (DMP): A structured repayment program typically arranged through a nonprofit credit counseling agency to help you pay down unsecured debts over time.

• Origination fee: An upfront charge that some lenders take from the loan amount to cover processing and underwriting costs.

Summary generated by AI, verified by MoneyLion editors

Sources

• Consumer Financial Protection Bureau: What is a personal installment loan?

• Consumer Financial Protection Bureau: What is a payday loan?

• Consumer Financial Protection Bureau: What is a debt relief program and how do I know if I should use one?

Jeanine Skowronski contributed to the reporting for this article.

Photo Credit: Fizkes / iStock.com