Is a personal loan right for you? Exploring the key benefits and disadvantages of a personal loan
Whether you’re facing an unexpected expense or saving for a major milestone – like medical costs, home repairs, or a wedding – a personal loan can be a practical way to cover costs. In the U.S. banking system, personal loans are unsecured loans offered by banks, credit unions, or online lenders. Unlike secured loans that require collateral, such as home loans and auto loans, personal loans are based primarily on your credit history, income, and overall ability to repay. In contrast, a personal line of credit offers revolving borrowing, variable interest rates, and flexible usage, making it different from the fixed structure of a personal loan.
Once you’re approved for a personal loan, you receive one lump sum of money that you repay in fixed monthly installments over a set period, usually between two to seven years. Because payments are structured and predictable, personal loans can provide both stability and flexibility – two qualities that make them appealing for many borrowers.
Still, deciding whether a personal loan is the right choice for you requires more than just knowing how they work. Understanding the benefits and disadvantages of a personal loan can help you make an informed choice, avoid unnecessary costs, and ensure you stay on track toward your broader financial goals.
In this guide, we’ll go over some of the key benefits of personal loans that apply when they’re used responsibly. These include the ability to consolidate high-interest debt, access competitive rates, enjoy predictable repayment terms, and use the funds for a wide range of needs. By the end, you’ll have a clear sense of whether a personal loan could be a smart and practical tool for your financial situation. As a financial tool, a personal loan can help you manage expenses, consolidate debt, or fund major purchases as part of your overall financial strategy.
What exactly is a personal loan?
A personal loan is a type of credit offered by banks, credit unions, and online lenders that leads to you getting a lump sum of money (usually $1,500 to $50,000) upfront. The approved loan amount is fixed at the outset and cannot be increased later. You then repay the amount you borrow in fixed monthly payments over a set period of time, usually two to seven years.
Most personal loans are unsecured, meaning they don’t require you to put down collateral. Instead, lenders approve you based on factors such as your credit history, income, and debt-to-income ratio. Borrowers often use personal loans to consolidate debt, cover unexpected expenses, or finance a major purchase, making them a versatile option for managing almost any type of financial need.
How the personal loan application process works
Personal loans are fairly easy to apply for, and that’s true whether you’re applying at a traditional bank or credit union or through an online lender. Many personal loan companies even let you “check your rate” and gauge your approval odds before you apply, meaning you can see if you may be eligible and what the loan terms would be before submitting a full application.
When you move forward with a loan application, you should plan on submitting information like your full name, home address, Social Security number (SSN), employer information, income, and more. The lender will do a credit check to confirm all the details you shared, which involves reviewing your credit report and may result in a hard credit inquiry that can temporarily affect your credit score. You may be required to submit additional information like pay stubs, tax information, or bank statements.
Some personal loan companies may take up to 10 days or longer to fund loans, while others can deposit funds directly into your bank account as soon as the next business day. This variation is why it’s important to shop around and compare multiple lenders before getting a personal loan. When evaluating lenders, consider their approval criteria—such as credit score, debt-to-income ratio, and stable income requirements—as well as factors like interest rates, fees, repayment terms, and funding speed to find the best fit for your needs.
7 key benefits of personal loans
If you’re considering a personal loan instead of other funding options like credit cards, it’s important to weigh both the advantages and disadvantages of personal loans. Compared to credit cards, personal loans often offer lower interest rates and fixed repayment terms, particularly for borrowers with strong incomes and good credit scores. While credit cards provide more flexible repayment options, they usually come with higher APRs. So, what makes obtaining a personal loan beneficial? Several key advantages can make personal loans an attractive choice. Here are some of the top benefits:
Benefit #1: Potential for debt consolidation
Debt consolidation is one of the most popular reasons to take out a personal loan. Consolidating debt involves using a new loan to pay off multiple existing debts, streamlining repayment into one manageable payment. By combining multiple debts – like credit card balances – into a single new loan balance, you can simplify your finances and begin working toward freedom from debt. You can consolidate credit card debt and other high-interest obligations into a single loan, making it easier to manage payments and potentially lowering your overall interest rate.
Not only can debt consolidation make the repayment process easier, but personal loans tend to come with much lower rates than other borrowing alternatives. This can lead to financial savings that make it that much easier to pay down debt.
Benefit #2: Lower interest rates than credit cards
According to the Federal Reserve, average personal loan interest rates for a 24-month personal loan are currently about half the average interest rate for credit cards. Many personal loans offer a fixed rate, which means your monthly payments and interest rate remain consistent, providing predictable payments and financial stability. This makes personal loans a much more affordable borrowing option if you need to finance something and pay it down over several months or years.
This benefit also ties back to debt consolidation. If you owed $10,000 in credit card balances at 20% APR and you paid $300 per month, it would take you four years and two months to pay it off. You would also fork over $4,718.05 in interest over that time.
If you paid the same amount monthly ($300) on a $10,000 personal loan with an APR of 10%, however, you would pay off the loan in just over three years with just $1,763.95 in interest payments.
Personal loan calculator
Benefit #3: Set repayment schedule
Where credit cards let your balance fluctuate and offer flexible monthly payments in any amount over your required minimum payment, personal loans come with a set repayment schedule (typically two to seven years). The repayment term or loan term determines the duration of the loan and directly affects your monthly payment amount. A longer repayment period can result in a lower monthly payment, which may make it easier for some borrowers to comfortably afford their payments. Understanding the loan term and repayment period is important for budgeting and ensuring the monthly payment amount fits your financial situation. This set schedule is less flexible overall, but it lets you focus on repaying your debt with the full knowledge of when you’ll become debt-free.
Benefit #4: Builds credit history
Making on-time payments on a personal loan can help you build credit history and your credit score over time. Lenders report your payment history to credit bureaus, and this information directly affects your credit score. Late or missed payments, especially those over 30 days late, can be reported to credit bureaus and significantly lower your credit rating, leading to poor credit. Maintaining a good payment record is essential to avoid poor credit and to ensure future borrowing opportunities are not hindered by missed payments.
Your credit score may even improve as you pay down your balance and owe less debt overall.
Transferring debt from credit cards to personal loans can also lower your overall credit utilization ratio – an important factor that determines 30% of your FICO credit score.
Benefit #5: Flexible use of funds
What are personal loans used for? While debt consolidation is one popular option, consumers can use personal loan funds for nearly anything they want. Popular uses for personal loans include weddings, fertility treatments, adoption expenses, home remodeling projects, medical bills, and making a large purchase. Personal loans are more flexible than other loans, which often have restrictions on how the funds can be used. However, unlike some other loans, personal loans generally cannot be used for college tuition or other educational expenses.
Benefit #6: Potential for fast funding
Maybe your car broke down and you need to pay for repairs quickly so you can get to work. Perhaps you owe someone money and you want to pay them back in a hurry, and without making them wait.
In either scenario, a personal loan can fit the bill. After all, many lenders will send your loan funds directly to your bank account within a matter of days after approval — or even the next business day.
Benefit #7: No collateral required
Unlike mortgages and car loans, which are secured loans requiring collateral, personal loans are typically unsecured and do not require any collateral. With secured loans, you risk losing your collateral—such as your home or car—if you default on the loan. In contrast, personal loans offer the flexibility to borrow money without putting your assets on the line. This unsecured nature makes personal loans more versatile than secured loans like mortgages, which are usually tied to a specific purpose.
Who can benefit most from personal loans?
Personal loans have the potential to benefit almost anyone, but they can be especially useful for people who need to consolidate high-interest debt or cover unexpected expenses. Loan funds from a financial institution, such as a bank, credit union, or online lender, can also be used to finance a major life event, such as a wedding or the adoption of a child.
Just remember that not everyone can qualify for personal loans, especially when it comes to options with the best rates and terms. Factors such as credit history, regular income and existing debt play a key role in determining eligibility and loan terms. A personal loan makes sense when it fits your financial situation and helps you achieve your goals responsibly.
Ideal candidates for personal loans
Most personal loan companies want applicants to have good or excellent credit, which includes FICO scores of 670 or higher. However, it’s possible to get personal loans with bad credit — or a score as low as 580 — with certain companies.
Other factors help determine personal loan eligibility as well, including having regular, proven income and a low debt-to-income ratio.
Overall, the best personal loans go to applicants with:
- Strong credit scores (670+)
- Steady income through employment or other guaranteed avenues
- Debt-to-income ratio of 36% or lower
When a personal loan may not be your best option
Potential disadvantages of a personal loan can vary based on your personal situation. For example, these loans may be difficult for some applicants (but not all) to qualify for. Consumers with low credit scores may also find that personal loans they’re eligible for don’t have the best rates.
Some personal loan lenders charge origination fees as an upfront cost for processing your loan application. An origination fee is typically a percentage of the loan amount and may be deducted from the funds you receive, reducing the total amount you get. Additionally, some lenders may impose prepayment penalties if you pay off your loan early, resulting in extra costs. Always read the fine print carefully to understand all fees, penalties, and terms before committing to a loan.
There are also some downsides when it comes to personal loans vs. credit cards and other funding options. The chart below shows how some of the alternatives to personal loans compare.
Personal loans vs. credit cards and alternatives
How to get the best personal loan terms
To qualify for the best personal loans on the market today, you need to be able to prove excellent financial health. The following tips can help you work toward this goal.
- Improve your credit score into the “good” range. If your credit needs some work and you can wait before you borrow money, taking steps to improve your credit before you apply for personal loans can help. Boost your credit by making on-time payments on all your bills and using credit improvement apps like Experian Boost.
- Pay down revolving debt. If you owe significant amounts on credit cards, paying down some of that revolving debt can help lower your credit utilization ratio. This can help improve your credit score, thus improving your chances at the best personal loans.
- Apply for a joint personal loan. You can also apply for personal loans with a joint borrower who has good or excellent credit, a strong income, or all of the above. Just remember that the joint borrower will be equally responsible for repayment of the loan.
- Compare rates with multiple lenders. Also, remember to shop around for personal loans with at least three or four different lenders. This will help you find loan companies with the lowest interest rates and most flexible repayment terms. Also, make sure to compare lenders based on the fees they might charge, including origination fees.
Best personal loan rates
Frequently asked questions about personal loan benefits
The main benefit of a personal loan is access to a lump sum of money with fixed, predictable monthly payments. They often have lower interest rates than credit cards, helping you save on interest and pay off debt faster. Personal loans can cover various needs, from unexpected expenses to major life events like weddings or adoptions.
A personal loan can be a net positive for your life if you use it to consolidate existing debt, save money on interest, or both. Personal loans used to fund major expenses or life events can also be rewarding.
The point of a personal loan is to provide borrowers with a lump sum of money that can be repaid in fixed monthly installments over a set period. These loans can be used to manage expenses, consolidate debt or fund major purchases while offering predictable payments and lower interest rates than other forms of credit.
Benefits of personal loans include set monthly payments, fixed interest rates, and the potential for interest savings compared to other types of funding.
You typically need to be at least 18 years old to get approved for a personal loan, although other requirements apply.
Conclusion
Personal loans offer a flexible and practical way to manage a variety of financial needs, from consolidating high-interest debt to covering unexpected expenses or funding major life events. With predictable monthly payments, lower average interest rates than credit cards, and the ability to access a lump sum without collateral, they provide both financial clarity and peace of mind.
By understanding the key benefits of these loans and carefully evaluating your own financial situation, you can determine whether a personal loan is the right tool to achieve your goals.
