Best Reasons To Get A Personal Loan (And When To Avoid It)
You’ve been considering a personal loan, but is it a smart choice? If you’re trying to get your finances in order, it might seem like the wrong strategy to actually take on more debt.
The great news is that a personal loan can be a smart financial tool to help keep from adding more debt in ways that are potentially more costly – such as running up your credit card balance or taking a payday loan – while simultaneously helping you manage the debt you have. Let’s find out how personal loans work, go over the best reasons to get a personal loan, and discuss a few situations where they might not be the best strategy.
First, let’s take a quick look at what all personal loans have in common.
A personal loan is an “installment loan.” That means they come with set terms up front, which means you’ll know:
- The total amount of money you’re being loaned
- How long the term is (or how long you have to pay it back)
- How much the fixed monthly payment will be
As you can see, an installment debt allows you to make progress toward paying off your total. By contrast, with revolving debt, like credit card debt, you can keep adding more purchases, making your debt grow ever larger. And since you have a variable payment, it can seem like you’re making payment after payment without seeing any progress toward payoff. With a personal loan, that defined payment term means that when you’ve made a set number of payments, the debt will be paid off. (Whew! That is a good feeling!)
Secured Personal Loan: What You Need To Know
Personal loans come in two types: secured and unsecured. A secured personal loan is backed by something that serves as collateral. You are probably familiar with a mortgage, which is a type of loan that’s secured with your house as collateral. You might decide to get a personal auto loan at a better interest rate than the dealer offers; in that case, your car would serve as the collateral to secure the loan.
The reason lenders offer secured personal loans is because they know that in the event you don’t make payments, they can repossess the item that is securing the loan, such as in the case of personal auto loans. And that’s something to consider: what would happen if your financial situation changed? Would you be at risk of losing your home, car or other property?
Unsecured Personal Loan: What You Need To Know
By contrast, an unsecured personal loan doesn’t require collateral. That’s why you’ll probably need to have a better credit score in order to be approved – the lender’s assumption will be that you’ll continue to responsibly pay back your loans as you have in the past. An unsecured personal loan might come with a higher interest rate, too, since the lender is taking a bigger risk by loaning you money that isn’t backed with an asset.
Reasons To Get Personal Loans For Debt Consolidation
One of the most common reasons people get a personal loan is to create a sort of debt consolidation loan. Personal loans can be part of a smart financial strategy to pay off debt since they allow you to take multiple bills (say from several credit card debts) and combine them into one loan with a single payment. You’ll often get a better interest rate than you have on your credit card debt, and of course, it’s far easier to make one payment than multiple ones, which is the whole premise behind debt consolidation.
As explained above, another benefit of a personal loan for debt consolidation is that it’s an “installment” loan, rather than revolving debt; there’s light at the end of the debt tunnel – you’ll be paying it off, but can’t add to it.
Should I Get A Personal Loan?
The answer depends on your goals. If you want to combine multiple bills into one fixed payment with a potentially lower interest rate for debt consolidation, as described above, then the answer is that it can be a wise financial strategy.
Another common – and financially sound – reason to get a personal loan is for home improvements. By using funds from a personal loan, rather than a credit card, you are likely able to achieve a lower interest rate. And since you’re ideally adding value to your home, it can be an expense that will pay for itself in the long run.
They also can be an alternative to payday loans, which is an interim loan that might fill a gap in your finances, but will come with crazy high interest that’s liable to leave you far worse off than before. A personal loan can be a better option than payday loans to weather a financial hardship and get you back on your feet.
You also might take out a personal loan for educational needs or medical bills or even for moving expenses or to help your small business grow.
However, in some instances taking out a personal loan may not be a smart financial move, and that’s typically when it includes “wants,” rather than “needs.”
And while that might be less costly than accruing more credit card debt with a potentially higher interest rate, you’re still going to be on the hook for some interest charges. It’s far more prudent to save for these items – or forgo them altogether – than rack up additional debt for something that doesn’t have inherent value nor qualify as an investment and might likely be long gone before the bills are paid.
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