If you have an emergency home repair or wish to make a large purchase, consider taking out a personal loan before you drain your savings account, pull out a credit card or put your home up as collateral.
Knowing when to consider a personal loan requires analyzing your current financial situation. In some circumstances, a personal loan is an ideal solution.
When it’s a good idea to get a personal loan
In the following situations, it’s a good idea to opt for a personal loan:
In other situations, it’s best not to get a personal loan. Instead, save so you can pay cash and don’t owe any interest. These situations include nonessential items that you are able to wait for, such as new furniture or a flat-screen television. If you need a personal loan to pay for everyday expenses, consider getting debt help, such as credit counseling.
Keep in mind that taking out a personal loan involves some risk. For instance, if your business venture fails and/or you declare bankruptcy, you’re still obligated to pay off the loan.
Common reasons to get a personal loan
Personal loans allow you to borrow money for a variety of reasons. They aren’t specific to a certain purchase or purpose, like auto loans or mortgages. You can take out a personal loan for just about any reason you desire, such as:
- Consolidating/refinancing high interest debt
- Home improvement or repair
- Wedding or engagement
- Medical procedure
- Home purchases, such as furniture and electronics
- Expanding or starting a small business
How personal loans work
Personal loans are installment loans. This means that after you receive the loan, which will come in a lump sum, you will be required to pay off the loan in installments. This may be monthly or semi-monthly.
Personal loans feature a specified number of payments and a fixed or variable interest rate. Fixed interest rates stay the same during the life of a loan. Such rates allow you to plan your budget and are a good option when interest rates are low.
Variable interest rates fluctuate according to market conditions. They usually start out with a low initial interest rate and over the life of the loan, the interest rate can rise when the prevailing interest rate does. Because of the possibility of the interest rate rising, it’s often safest to take out a variable interest rate when the loan payoff term is short, such as 1-3 years.
Interest rates for fixed and adjustable rate personal loans tend to start at 7% and can go up to 15% or higher, depending on the lender and your credit score. Payday loans have expensive triple digit interest rates.
In addition to interest rates, you may also have to pay other fees when getting a personal loan, such as origination fees, which are charges for processing the loan. These fees may be taken out of the loan amount itself.
Types of personal loans
There are several main types of personal loans. Which type you choose will depend on your credit score. The higher your score, the better terms you are likely to get when borrowing money for personal reasons.
- Unsecured loans:
These loans are also known as signature loans, because your signature guarantees you’ll pay back the loan. To qualify, you must have good credit of 670+, as well as an on-time payment history. If you don’t have good credit, it’s possible to get an unsecured loan if you have a cosigner with a good credit score.
- Secured loans:
These loans are easier to get than unsecured loans, because you put up property as collateral–such as jewelry. If you fail to make payments on the loan, the lender can confiscate your personal property in lieu of payment.
- Peer-to-peer loans:
These specialized loans are an alternative to traditional personal loans. This type of loan involves individuals lending money to borrowers. Such lenders often require a great deal of personal information from the prospective borrower, and you may need to wait for an extended period of time to see if the loan has been approved.
- Payday loans:
These are short-term loans for small dollar amounts that are loaned based on your future paycheck. You get a loan and typically have two weeks to pay the money back. If you don’t, the lender rolls the loan over, refinancing it and adding additional fees and interest. Payday loans are easy to get and don’t need a credit check.
Personal loans are a convenient and flexible way to fund a wide variety of expenses. Before applying for one, weigh all your options so that you can make the best choice for your financial situation. Check out the SuperMoney personal loan reviews page to see what the various lenders have to offer.
Julie Bawden-Davis is a widely published journalist specializing in personal finance and small business. She has written 10 books and more than 2,500 articles for a wide variety of national and international publications, including Parade.com, where she has a weekly column. In addition to contributing to SuperMoney, her work has appeared in publications such as American Express OPEN Forum, The Hartford and Forbes.