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Personal loans are not always bad. If you work with a reputable lender, use the loan for the right reasons and can commit to paying it back, then a personal loan can be a smart option.
On the other hand, if the loan you’re considering comes with a triple-digit interest rate, and you have limited or unsteady means to pay it back, then a personal loan will do you more bad than good.
What is a personal loan?
A personal loan is money borrowed from a lender that you pay back with equal monthly payments, or installments, over a fixed period, typically two to seven years. You can get personal loans from banks, credit unions and online lenders.
In return for borrowing, you pay interest on the loan. Interest rates on personal loans range from about 6% to 36%. Borrowers with good to excellent credit (above 690 on the FICO scale) are more likely to qualify and receive a rate at the lower end of that range.
If your credit is bad, you can boost your chances of qualifying by building your credit and reducing your debt. There are some lenders that offer bad-credit personal loans, but expect higher rates.
When is a personal loan a bad idea?
There are a few instances when it’s better to avoid a personal loan:
It’s a no-credit-check loan: Lenders that don’t check your credit can’t accurately assess your ability to afford the loan. This means more risk for them and much higher interest rates for you. If your credit is bad, but you need to borrow, exhaust all other options first.
» MORE: What are no-credit-check-loans?
Managing debt is tough for you: A debt consolidation loan can ease your debt burden, but it requires that you use the loan to pay off your other debts and avoid taking on any more.
A good first step toward getting better at managing your debt is following a budget that accounts for needs, wants and debt payments.
You have cheaper alternatives: Even in an emergency, we always recommend taking a moment to consider alternatives to borrowing. If your credit is good, you may qualify for a 0% interest credit card. Medical debt can often be covered with a payment plan. Your employer may offer a cash advance on your paycheck. Take our quiz below to explore alternatives.
When is a personal loan a good idea?
A personal loan can be a good idea when you use it to reach a financial goal, like paying down debt through consolidation or renovating your home to boost its value.
It can also make sense to use a personal loan for large purchases that you don’t want to put on a credit card. Some lenders offer loans up to $50,000, and the fixed monthly payments can be easier to budget than credit cards with revolving interest.
Most financial experts recommend against using a personal loan for discretionary purposes, like vacations or extravagant weddings. That’s because borrowing can be expensive, and you might still be paying for your wedding years after the honeymoon.
Saving is the best — and cheapest — way to pay for such items. However, if you must borrow, and your income is stable enough to commit to a few years of monthly payments, then a personal loan can be cheaper than many credit cards.
Is a personal loan bad for my credit?
A personal loan can help your credit score if you follow the golden rule of managing your loan: Never miss a monthly payment. On-time payments, whether toward personal loans or credit cards, account for 35% of your credit score, and missing even a single payment can erase 100 points or more.
Applying for a personal loan, which requires a hard credit pull, can ding your scores by five to 20 points.
How to choose a personal loan
If you’ve weighed the options, and you’re set on a personal loan, consider these factors to help you find the best loan for you:
Estimate your payments: Use a personal loan calculator to estimate the interest and monthly payments based on your credit score and loan amount. Factor those payments into your budget to ensure you can afford the loan.
Compare rates across lenders: It pays to shop around for the best combination of low rates and fees. Most online lenders let you pre-qualify to check rates, without affecting your credit, by using a soft credit check.
Loan features: Some lenders have mobile apps where you can track your loan. Others offer flexible payment schedules that allow you to change a due date or defer a payment. If you’re consolidating your debt, some lenders will send your loan proceeds directly to your creditors.
Additional benefits: Take advantage of extras like free credit score monitoring, financial education resources and career counseling that may be offered by your lender.