A personal loan is a lump sum borrowed from a financial institution that you can spend on various expenses. This is as opposed to many loans that are restricted to a specific purpose, such as mortgage loans. Whether a personal loan is best for you depends on your unique circumstances, as they can be helpful or harmful depending on how they are used.
When Is a Personal Loan a Bad Idea?
Scenarios where personal loans are a bad idea typically have to do with your overall financial health or the specific type of personal loan.
- You have existing debt: If you have existing debt, it is typically not a good idea to pile on more debt and create further risk and pressure on your financial situation.
- You have a poor credit score: This often goes hand-in-hand with the previous scenario. If you have a poor credit score you typically won’t be able to get ideal loan terms. Your interest rate will likely be much higher than it would be for a borrower with good credit.
- It’s a no-credit-check loan: No-credit-check loans are very high risk for the lender, and therefore typically have high interest rates.
- Better options are available: You should assess your unique circumstances and make sure there aren’t better options available. For example, if you have small, ongoing expenses, a line of credit may be a better option than a personal loan. Additionally, many large expenses are better suited to specific loan agreements, such as a mortgage loan for the purchase of a house.
When Is a Personal Loan a Good Idea?
However, personal loans can also sometimes be very helpful, as in the following scenarios:
- You want to consolidate debt: Personal loans can be used to consolidate debts, and ideally should lower your overall interest rate on your debt if used in this way.
- You have a good credit score: Typically, if you have a good credit score, personal loans will have a relatively low interest rate.
- You want to build credit: If you make your payments on time, a personal loan can improve your overall credit score. However, you should pay off any existing debt and ensure you have the means of paying the loan back before taking this approach.
- You have a large, necessary expense: Personal loans are typically used for large expenses, especially those that are relatively unexpected and/or involve a wide array of underlying expenses. This includes affairs such as weddings, funerals, or downturns in business.
Once you have determined whether a personal loan makes sense for your unique financial circumstances, you should begin looking into what the outlook would be if you successfully applied for one.
Important Considerations for Getting a Personal Loan
There are some financial considerations you should always make before taking out a personal loan, including:
- Do you have existing debt?: If you have existing debt, it may not be a good idea to add more by taking out a personal loan. However, if your credit is still in good standing and you have a reasonable plan to pay off the existing debt and the personal loan, it can be done responsibly.
- Can you pay the loan back?: As mentioned, before taking out a personal loan, you should always review your budget and ensure that you have enough money to make your payments on time, with room to spare.
- What Is your credit score?: Although you can get a personal loan even if you have a poor credit score, a poor credit score can negatively impact the terms of your loan, such as your interest rate. If possible, it may be beneficial to take some time to improve your credit score before applying for a personal loan.
- Which lenders are available to you?: You should always shop around for a lender if you intend to get a personal loan, to ensure that you get the best terms available to you.
In short, personal loans are useful for a wide variety of purposes, but they can be a bad idea if your finances are not in order or you have a better alternative available.
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