Should You Take out a Personal Loan?
Whether you’re trying to cope with unexpected expenses, or find the extra cash for your next home remodel or family vacation, a personal loan may be a good option to consider. Personal loans are a convenient way to secure financing for just about any kind of expense. The money can be in your hands within a day of approval.
If you’re planning to borrow, let’s look at whether a personal loan is the right choice for you.
What Is a Personal Loan?
Personal loans are known as “unsecured” debt because they are not backed by collateral—such as your home or car. Lenders will use your credit score to help determine whether to give you a personal loan and at what interest rate. Depending on your credit history, the interest rates on personal loans can be higher than secured loans, so you may want to consider personal loans only for expenses you intend to pay off quickly.
Personal loans are not like credit cards, which are revolving loans. Credit cards, and other revolving loans, have no fixed payment term and often have a fluctuating interest rate. Personal loans are a type of installment loan. Installment loans have a fixed repayment term (usually two to five years), and often carry a fixed interest rate. You’ll receive a lump sum up front and then pay the money back (plus interest) in regular monthly installments.
Should I Get a Personal Loan or a Home Equity Loan?
These two types of loans both let you borrow money that can be used for a variety of purposes, which is why you’ll often hear them mentioned in the same breath. However, one of them may be better for you than the other. Here’s what you should to consider:
- Do you have a decent amount of equity in your home? If you’re a homeowner, you need to consider if there is sufficient equity in the home that can be used as collateral for the loan.
- Do you need the money immediately? The process to apply for a personal loan can be completed in a matter of minutes. After you’ve completed and submitted the application, a credit decision is usually provided the same day and funds are generally disbursed the same day of your approval—or a day later. A home equity loan or a home equity line of credit (ELOC), require more information since you are pledging your home as collateral. The time frame, from completing an application to disbursing funds, could take anywhere up to two to four weeks.
- What interest rate do you want? A home equity loan or ELOC can offer better rates than a personal loan since they are secured using your home as collateral. A home equity loan can either be a line of credit (ELOC) with a variable rate or a term loan with a fixed rate. A personal loan is a term loan with a fixed rate that is unsecured. Also, the amount you can borrow and repayment term you can take on a personal loan is significantly less than on a home equity loan or ELOC.
What Can I Use a Personal Loan for?
The flexibility of a personal loan is one of its biggest advantages: you can put the money towards just about anything you need. Here are some uses to consider:
- Unexpected expenses. While we highly recommend building up an emergency fund, expenses can still sometimes overwhelm you. You could max out your credit card paying a car repair bill or covering a medical expense—or, you could consider a personal loan, which could offer a lower interest rate. Because you can get a personal loan more quickly than an equity loan, they can be a good option when you need to handle the unexpected.
- Home improvement. If you need to finance repairs or a major remodel on your home, but don’t yet have the equity in your home to do it through a home equity loan, a personal loan is a good alternative. You can get a reasonable rate and obtain the financing you need to get your project done.
- You can use this type of loan to consolidate debt, which may help simplify and reduce your monthly expenses.
- Big expenses you can’t (or don’t want to) put off. Are you trying to finance your wedding or the next big family vacation? These big expenses can be tough to afford and take forever to save for. Instead of waiting, you could consider taking out a personal loan.
What to Do Before Applying for a Personal Loan
Before you apply, make sure you understand all the terms of the loan financing. Additionally, take a few steps to ensure your finances are in order:
- Check your credit report. If there’s any inaccurate information, report it to both the credit bureau and the creditor—both will investigate and remove inaccuracies, which can really improve your credit score.
- Pay off credit card debt. If you use the personal loan to payoff credit card debt, you can improve your monthly cash flow, improve your credit score, and have peace mind with a fixed rate since many credit card rates are variable.
- Don’t apply for multiple loans at once. Yes, this can also hurt your credit score. Discuss options with your lender to decide if their available loans are a good fit. If not, you can move on to your next choice.
- Be sure you can afford it before you sign the paperwork. Do the math (or ask your lender for assistance) to find out what your payments will be. Then make sure it works within your monthly budget.
- Prepayment penalty. Ask you lender if they charge a prepayment penalty. A prepayment penalty requires you to pay a fee to your lender if you want to pay off your loan prior to maturity.
- Application fees. Ask your lender if they charge an application fee. The majority of the lenders do not.
Regardless of your decision, it’s always best to research and explore all of your options first to determine what type of financing will be the best fit for your situation. PenFed, for example, has both personal and equity loan financing available.