If you have a big goal or project to accomplish and are looking for sources of cash, you’ve probably already considered the typical sources: credit cards, loans from friends and family, home equity loans and the like.
But there is another option you might not have thought of – personal loans. If you’ve never heard of this product, you’re not alone. For help figuring out what personal loans are and if applying for one is right for you, take a look at the details below.
What is a personal loan?
As the name implies, personal loans are a type of credit that consumers take out for a variety of personal reasons. Unlike mortgages or auto loans, personal loans aren’t earmarked for a specific purpose – you could theoretically take out a personal loan for any reason you want.
Personal loans are installment loans; if you’re approved, you’ll receive a lump sum of cash up front, then you’ll be expected to repay it in fixed amounts on a monthly basis until the loan’s term is up. Because personal loans are unsecured, their interest rates are typically higher than secured loans. However, their rates are generally lower than most credit cards.
Keep in mind that in many cases you’ll need good credit to qualify for a personal loan. If you don’t have a decent credit score, you may need to pursue other options for financing your purchase or activity.
Possible reasons for getting a personal loan
One of the great things about personal loans is that they offer a lot of flexibility. Although you’ll probably have to report the loan’s intended purpose on your application, you’ll generally have a lot of leeway in what you can use the funds for.
Some common reasons for getting a personal loan are:
- Consolidating or refinancing high-interest debt
- Making a large purchase (such as an appliance or electronic device)
- Taking a vacation
- Making a home improvement
- Financing a small business purchase or expansion
- Paying for a medical procedure or expense
- Paying for a wedding or engagement ring
When it makes sense to get a personal loan – and when it doesn’t
There are some situations where it makes a lot of sense to opt for a personal loan. For example, consolidating or refinancing high-interest debt is a great reason to opt for a personal loan.
As of June 2014, the average credit card interest rate hovered around 15%. If you have good credit, you might be able to get a personal loan at a rate as low as 6-7%. If you choose to pay off your plastic with a personal loan, you could save a lot of money on interest. Plus, as opposed to consolidating with a 0% card, you won’t have to worry about paying a hefty balance transfer fee.
It also might be smart to consider using a personal loan for a home improvement project. Although you’ll probably pay a higher interest rate than you would on a home equity loan, you won’t be putting your house on the line as collateral.
On the other hand, it’s probably not a great idea to use a personal loan for non-essential consumer purchases, like a wedding or a vacation. It’s true that you’ll likely get a better rate than you would with a credit card (see above), but in the end you are still paying interest. Ideally, saving up for big-ticket items is the way to go. That way, you won’t have to worry about finance charges at all.
One final note: Using a personal loan for a medical procedure or a small business purchase is a judgment call. If you’ll get better terms with the personal loan than you would with a payment plan at your doctor’s office or a small business loan, it might make sense. But be sure to carefully weigh all of your options first.
The takeaway: Personal loans are attractive because they’re a flexible way to fund a big expense. But it only makes sense to take out this type of loan if you’re using it to save money on interest or avoid putting a large asset at risk. Otherwise, the Nerds recommend saving up for the item or experience you want to buy – after all, good things come to those who wait!
Loan approved image via Shutterstock