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A personal loan can be a way to consolidate high-interest debt or finance a large expense like a home improvement project. Interest rates on personal loans can be lower than on some credit cards, especially if you have good credit.
But financial experts typically advise against using a personal loan for that beach vacation or the latest flatscreen TV. For discretionary purchases like these, it’s best to pay with cheaper options like a 0%-interest credit card or, even better, money you’ve saved up.
What to know about personal loans:
A personal loan is unsecured and can be used for almost any purpose.
Applicants with high credit scores and low debt often get the lowest rates.
A personal loan can be a good way to consolidate high-interest debt.
Savings or low-interest credit cards are better for vacation or discretionary spending.
What is a personal loan?
Personal loans are a type of credit that consumers can take out and use for almost any reason. Unlike mortgages or auto loans, personal loans don’t need to be earmarked for a specific purpose.
Personal loans are installment loans; if you’re approved, you’ll receive a lump sum of cash that you repay in fixed amounts on a monthly basis until the loan term expires.
To determine whether you qualify for a personal loan, a lender will check your credit and income to gauge your ability to afford the loan. Applicants with high credit scores, strong income and low debt usually receive the lowest rates.
When is a personal loan a good idea?
A personal loan can be a good idea when it’s less expensive for you than other forms of credit and when you can comfortably afford the monthly payments for the length of the loan term.
Here are common reasons to take out a personal loan:
Consolidate high-interest debt: Getting a personal loan is one way to consolidate high-interest debt, like expensive credit card debt, into a single payment. Ideally, the personal loan has a lower interest rate than your existing debt and allows you to pay it off faster.
For example, say a borrower with good credit has two credit cards with a total balance of $20,000 and an interest rate of 24.99%. Every month they make $400 monthly payments toward each card. By rolling those debts into a single personal loan with an interest rate of 18% paid over three years, the borrower could save $2,770, according to NerdWallet’s debt consolidation calculator.
Home improvement: Using a personal loan for a home improvement project can make sense, especially if the project adds value to your home. You avoid racking up credit card debt or having to pledge your house as an asset like with a home equity loan.
How to get a personal loan
The process of getting a personal loan starts with checking your credit score. You can then assess your creditworthiness and fix any issues.
Next, figure out how much you need to borrow and calculate estimated rates. This can give you the information you need to pre-qualify — getting a sneak peek at the offers you may receive from a lender — and compare the potential rates between online lenders, banks and credit unions.
Then, consider other credit options like 0%-interest credit cards, secured loans or adding a co-signer. Before committing to a financing option, read the fine print to see if there are any fees, and learn more about features the lender offers like direct payment to creditors or flexible payment dates.
If you decide to move forward, gather the required documents so you are ready to apply for the loan formally.
When do personal loans not make sense?
Discretionary spending: Personal loans are an expensive financing option for nonessential expenses, like an extravagant wedding or a dream vacation. Instead, start saving now for big-ticket items so you can avoid finance charges altogether.
Medical costs: Medical bills can often be paid through a lower-cost payment plan with a doctor or medical credit card, rather than a personal loan. Consider a personal loan only if you can’t get better terms.
Emergency expenses: Rainy-day or emergency funds are often the best courses of action for emergency expenses. Personal loans may seem far cheaper and less risky than other sources like payday loans, but they can still involve high interest rates, especially for borrowers with poor credit. Here are local resources for alternatives to payday loans.