Pros and Cons of Personal Loans: What You Should Know Before You Borrow

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Personal loans are lump-sum installment loans commonly used to fund emergency expenses or consolidate high-interest debts. They have their upsides, including flexible borrowing limits, fixed repayment schedules and potentially low annual percentage rates (APRs).

There are also downsides to personal loans. You’re locked into a monthly payment for the duration of the loan’s term and will often pay interest and fees for the financing.  

What Are the Pros and Cons of Personal Loans?

Here’s a fast and easy comparison of the benefits and drawbacks to a personal loan.

Pros of Personal Loans 

Flexible Use 

Most lenders offer personal loan amounts ranging from $1,000 to $100,000. You can use these funds for almost all non-illegal expenses.

Common personal loan uses include examples such as:

• Consolidating high-interest debts
• Financing a large, but necessary purchase
• Making home improvements

There are some notable exceptions to what you can’t use a personal loan for, such as student loans, gambling and cryptocurrency.

Fast Funding

Personal loan applications aren’t particularly onerous. You can complete most, if not all, of the process online, and lenders generally require less paperwork than they would when you’re applying for a mortgage.

Some companies can provide same-day funding, with most disbursing monies between one and seven business days. Learn more about the process on how to get a personal loan.

Fixed Rate and Repayment Schedule

Unlike credit cards, most personal loans come with fixed interest rates, meaning your APR can’t change over the loan’s term. Your loan’s term, typically between 12 to 60 months, is effectively your repayment schedule. If all goes well, your monthly payment remains the same until the debt is repaid.  

Lower APRs for Borrowers With Good Credit

The average interest rate on a two-year personal loan is just over half the average rate on a credit card, according to recent Federal Reserve data.

Qualified borrowers can qualify for even more favorable terms, as top personal loans offer APRs as low as 6.5%.

No Collateral Required

Most personal loans are unsecured, meaning you don’t have to put up a personal asset, like a home, car, or collectible, to back the funds. There are secured personal loans, however, for people with poor or thin credit.  

Potential to Improve Your Credit 

Used correctly, a personal loan is a great opportunity to build good credit as it helps you establish a lengthy payment history. It’s also likely to add some variety to your credit mix.

Credit scoring models — and lenders — look to see that you have experience managing different loan types, including:

• Credit cards
• Mortgages
• Personal loans

Cons of Personal Loans 

Increases Your Debt Levels 

Borrowing money is risky — and rarely free. Personal loan holders will pay interest on their outstanding balance and may also incur other upfront or back-end fees. 

“Also, you’ll want to ensure you’re not borrowing more than you can afford,” said Steve Azoury, chartered financial consultant and owner of Azoury Financial. “This may only lead to more financial strain.”

High APRs for Borrowers With Bad Credit

If you have so-so credit, you’ll likely qualify for above-average personal loan interest rates.

On the other hand, if you have poor credit, you might only qualify for a lender’s worst terms. Some personal loans have APRs as high as 36%.

Ancillary Fees 

Many personal loans have origination fees, documentation fees, non-filing insurance fees — such as for for collateralized loans, as well as late fees.

Some personal loans charge prepayment penalties, either as a fixed amount or a percentage of the outstanding balance, if you pay off the loan early. 

One More Bill To Budget for 

Unless you pay your loan off early, you’ll have to make a monthly payment until the end of the term. That can become particularly challenging if you unexpectedly lose your job or have an emergency to pay for.

Potential To Hurt Your Credit Score

A new personal loan adds debt, a hard inquiry and a young credit account to your credit report, which can all lower your credit score. If you mismanage your loan, the negative effects are often more severe and long-term.

When Is a Personal Loan a Good Idea? 

Personal loans can benefit your financial situation in the following scenarios.

You’re Consolidating Credit Card Debt

Outstanding credit card balances are notoriously pricey. Plus, the ability to pay off and re-run up a balance can create a cycle of debt for undisciplined spenders. As such, people with high-interest credit card balances might consider a personal loan to consolidate their debts and save on interest. 

You Need To Cover a One-Time Expense

A personal loan’s lump sum can help you cover an emergency or something unexpected. You could also use it for a carefully planned expense if you’ve got a solid payoff plan in place.

You Qualify for a Low Interest Rate

Whether you’re looking to consolidate credit card debt or cover a large one-time expense, a personal loan is only your best option if it secures you more favorable or the most favorable terms. 

You Have a Reliable Income

Otherwise, you may struggle to make monthly payments. “Not making consistent payments can result in hefty fees as well as damage to your credit profile,” said Leslie H. Tayne, founder of Tayne Law Group, a debt resolution firm.

When Is a Personal Loan a Bad Idea? 

Personal loans have major risks in the following scenarios.

You’re Borrowing To Cover Everyday Expenses

That’s a sign of more deeply rooted financial issues and could warrant outside help. Non-profit credit counseling agencies can offer free advice or negotiate with your creditors to set up a debt management plan (DMP) for a fee.    

You Already Struggle With Debt Payments

In this case, you may need to explore more extreme debt relief solutions, such as debt settlement or bankruptcy.

You Don’t Qualify for a Good Rate

Or, you won’t qualify at all. “It can be hard for consumers with subprime credit to get approved,” Tayne said. “Typically, lenders like to see a good to great credit score … and a steady stream of income.”

You’re Unsure How You’ll Repay It

The purpose of a personal loan is to consolidate other debts, cover the costs of home improvements, financial emergencies, or other larger purchases,” Azoury said. “If the personal loan doesn’t fit into your budget, then you should avoid it at all costs.”

Who Should and Shouldn’t Get a Personal Loan?

Good for: 

• People with good credit 
• Borrowers looking to consolidate high-interest debt 
• Those who need quick cash for emergencies or big expenses 
• Applicants with stable income and manageable existing debts 

Not ideal for: 

• People with bad credit who can’t qualify for low APRs
• Borrowers looking to cover everyday expenses
• Those who want quick cash for non-emergencies or discretionary expenses
• Applicants with low-to-no or unstable income

Alternatives to Personal Loans 

Consider these alternatives if a personal loan doesn’t fit your financial profile.

• Credit cards: You can skip interest entirely with a credit card if you pay your monthly balances in full. Most come with a grace period, giving you 21 to 55 days before your APR accrues on purchases.
• 0% introductory APR credit card: If you need a little more time to repay a purchase or high-interest credit card balance, consider a 0% introductory APR credit card, which allows you to skip interest for a specified period, typically 12 to 24 months. You’ll pay a fee for transferred balances, though.
• Home equity loans or HELOCs: This financing lets you borrow against the portion of your home that you own. It’s an option for homeowners who can qualify for a low interest rate, although you risk losing the property if you can’t repay what you’ve borrowed.
• Buy Now, Pay Later (BNPL): BNPL programs provide you with some money to pay for a purchase at the point of sale. You repay the funds over a short period of time at no-to-low interest. If you miss a payment, you’ll incur fees, however
• Borrowing from family or friends: This option can help you avoid interest or damage to your credit, although you may risk straining your relationships if the debt goes unpaid. 

Where To Take Out a Personal Loan 

Not sure where to take out a personal loan? Here’s a rundown of common providers.

• Banks: Traditional lenders like banks have strict underwriting requirements, but often offer competitive rates and terms for highly qualified borrowers.
• Credit unions: These member-only organizations are known for low interest rates and flexible payment terms.  
• Online lenders: Known for particularly fast approval processes, online lenders are often willing to work with borrowers across the full credit spectrum.
• Peer-to-peer (P2P) platforms: These alternative marketplaces connect investors and borrowers. Their loans can carry high rates, particularly for borrowers with bad credit, but often offer lower underwriting standards.

Questions to Ask Before Getting a Personal Loan 

Use the checklist below to determine if a personal loan is the right choice for you.

• What is my credit score, and what terms will it qualify for?
• What is my estimated interest rate?
• Can I afford the monthly payment?
• What fees does a lender charge?
• What will the loan cost me overall?
• Is there a prepayment penalty?
• Is my income stable enough to support the financing long term?
• What do I plan to use the loan for?
• Will the personal loan benefit or harm my current financial situation?
• What other outstanding debts do I have to juggle?
• Are there better alternatives for my situation?
• Have I compared multiple lenders to find the best offer? 

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