Benefits and Drawbacks of Obtaining a Personal Loan

Natalie Thomas
An agent explaining the nature of a personal loan to a client.
Reading Time: 3 minutes

A personal loan is a lump sum for flexible use that is repaid to the lender in fixed installments. Although many characteristics of the loan, such as interest rate, will depend on each unique loan agreement. There are several distinct advantages and disadvantages to getting a personal loan.

Advantages of Personal Loans

The advantages of personal loans largely have to do with the wide range of opportunities they can provide.

Versatility

As opposed to many other types of loans, a personal loan can be used for any purpose. For example, while a mortgage loan must be used exclusively for the purchase of a home, the money from a personal loan could be used to pay housing costs, as well as for auto payments, credit card expenses, etc. It can be used for virtually anything.

Flexibility

As opposed to many other types of loans, personal loans are often paid over a fairly long period of time — typically at least a year. The smaller monthly payments are much easier to handle for many people. As a point of contrast, payday loans typically need to be repaid within a month

Additionally, the process of acquiring a personal loan can be very fast — sometimes taking less than a week. Therefore, personal loans are a great option for emergency funding in the face of unexpected financial difficulty.

Options

There are many options available when it comes to personal loans, so there is an opportunity to shop around. This applies to both the parameters of the loan and the amount, which can vary widely. The wide array of options available even benefit people with poor credit, as you can acquire a personal loan regardless of the state of your credit, although the parameters of the loan (such as the interest rate) may not be as desirable. You also typically do not need to provide collateral for a personal loan, although rarely secured personal loans will require it.

Credit-Building Opportunities

If you acquire a personal loan and make the payments on time, it can improve your credit score. Additionally, you can use a personal loan for debt consolidation. It is possible to consolidate your unsecured debts (such as credit card debt and medical bills) into one fixed monthly payment. This is typically done not only for the sake of convenience, but also to lower the interest rate on your debts. In paying back your debt, you can significantly improve your credit score, especially if you can remove the record of the debt from your credit report.

Disadvantages of Getting a Personal Loan

Disadvantages of personal loans largely have to do with the parameters of such loans, and the potential they have to negatively affect your finances if not used properly.

Fees and Penalties

Some lenders charge an origination fee for personal loans. These are typically between one and six percent of the total loan amount. Prepayment penalties also sometimes apply. Additionally, late fees may apply if you do not make your payments on time.

Fixed Payments

Because personal loans are paid off in fixed monthly payments, the borrower must be able to pay off the loan within the fixed time period that they agreed to, as opposed to other forms of loans which can be paid off over a longer, unspecified time period.

Risk of Debt and Damage to Credit

If you take on a larger personal loan than you can handle, you may find yourself in debt. Meanwhile, in turn, this debt could negatively impact your credit score.

Scam Risks

There are many personal loan scams, so it is important to do research on potential lenders while you shop. Additionally, you should be wary of a personal loan offer if the “lender” is pushy, requests unconventional payment methods, or does not follow a typical vetting process, e.g. a credit check.

Who Can Benefit From Getting a Personal Loan?

There is a wide variety of people who can benefit from getting a personal loan, including:

  • Anyone who intends to use their loan for multiple purposes;
  • Anyone who needs a loan quickly, but needs time to pay it back;
  • Someone who doesn’t have collateral;
  • Someone who wants to build credit.

Alternatives to Personal Loans

If a personal loan sounds like it may not be the choice for you, there are other options to consider. Alternatives to personal loans could include:

  • Credit cards: As in the case of personal loans, the particulars of a credit card depend on factors like the lender and your credit score. However, credit cards may offer additional benefits, and may be better suited for smaller, ongoing purchases.
  • Peer-to-peer loans: A peer-to-peer loan allows borrowers to be matched with investors on a lending platform, as opposed to borrowing from a more traditional financial institution.
  • Home equity loans: Home equity loans allow you to borrow against the equity in your home. Home equity loans typically have very low interest rates.
  • 401k loans: A 401k loan allows you to use money that is already in your retirement fund.

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