A personal loan is an option if you’re looking to consolidate high-interest debt or finance a large expense like a home improvement project. Interest rates on personal loans are typically lower than credit cards for borrowers with good credit, and most personal loans are unsecured, meaning they don’t require collateral.
But financial experts generally advise against using a personal loan for a weeklong stay at the beach or a new TV. For discretionary purchases, it’s best to choose less expensive alternatives first, like a 0% interest credit card, or — the cheapest option — money you’ve saved up.
What is a personal loan?
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 can use the loan for almost any reason.
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.
» MORE: What credit score do you need for a personal loan?
To determine whether you qualify for a personal loan, a lender will check your credit and income and gauge your ability to afford the loan. Borrowers with the highest credit scores typically receive the lowest rates.
» MORE: 5 ways to boost your approval odds
When should I get a personal loan?
Taking a personal loan can make sense when it’s less expensive than other forms of credit, and when you can comfortably afford the monthly payments for the duration of the loan term.
Here are common reasons to take out a personal loan:
Consolidate high-interest debt: Taking a personal loan is one way to consolidate debt into a single payment. Ideally, the loan has a lower interest rate than your existing debt and allows you to pay off the debt faster.
For example, a borrower with good credit who has two credit cards with a total balance of $20,000, an interest rate of 24.99%, and makes $400 monthly payments toward each card could save $2,770 by rolling those debts into a single loan with an interest rate of 18% paid over 3 years, according to NerdWallet’s debt consolidation calculator.
» MORE: Compare debt consolidation loans
Home Improvement: Consider using a personal loan for a home improvement project if it adds value to your home. You won’t rack up credit card debt or have to pledge your house as an asset as you would with a home equity loan.
» MORE: Explore personal loans for home improvement
When do personal loans not make sense?
Discretionary spending: Personal loans are an expensive financing option for non-essential expenses, like an extravagant wedding or vacation. Instead, start saving for big-ticket items to avoid finance charges altogether.
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Medical costs: Using a personal loan for medical expenses typically only makes sense if you can’t get better terms with a payment plan through your doctor’s office or a medical credit card.
Emergency expenses: Personal loans are far cheaper and less risky than payday loans, but can still involve high interest costs, especially for consumers with poor credit. If you don’t have an emergency fund, check local resources for payday alternatives.
