Personal loans can be obtained from either a bank or a credit union. Personal loans are normally unsecured which means that you will not have to use any collateral in order to get approved for the loan. You can use them for a wide variety of things, unlike auto or mortgage loans. However, there are also some drawbacks to taking out a personal loan that you should be aware of.
Advantages of Personal Loans
One of the first ways that obtaining a personal loan can benefit you is by building your credit. Credit cards and installment loans make up about 10% of your credit score. You can only increase your credit score so much by using credit cards for example. It doesn’t matter if you use them and pay them off each month on time, they will only affect your score so much. You can improve your score by adding another form of credit such as a personal loan. In the beginning, however, your credit score may drop a few points. This is because anytime you apply for new credit a new inquiry gets added to your credit history causes a minor drop in your score. This will change as you begin making payments on your personal loan.
Another pro of taking out a personal loan is that you can use the loan to pay for planned expenses. You can also take advantage of a much lower interest rate than credit cards have. Paying off other expenses with a credit card can backfire. You can use a personal loan to plan a wedding, buy new tires for your car, or even take a vacation. Always remember that your interest rate is dependent upon your credit history and score.
Taking out a personal loan will also allow you to consolidate other debt. Having several credit cards and a few medical bills can be a lot to keep up with. It can also be frustrating to try and keep up with more than one minimum monthly payment. By taking out a personal loan to pay off your other debt, you will have ended the nightmare of keeping up with multiple accounts. Being able to just pay one bill a month will simplify your life.
Loan approval is also quick when you apply for a personal loan. Mortgage and home equity loans, on the other hand, can take close to a month to obtain approval. You can apply for a personal loan and have an answer in as little as 24 hours. Once you are approved, the money is normally deposited into your account within 24 hours. This entire process can take anywhere between 2-3 days.
Disadvantages of Personal Loans
Personal loans also come with some disadvantages. One of the first disadvantages is that you may end up getting trapped in a cycle of debt. Even if using a personal loan to consolidate your debt, you will still have all of the old debt. It will just not look the same. You may end up paying off your credit cards with your personal loan but then begin to use the credit cards again, which in turn will make your balances high. You could potentially dig yourself into a much deeper hole.
Second, personal loans have higher interest rates than some other loans. A person that is trying to obtain a personal loan but has excellent credit will get a better rate on home equity than on a personal loan. The advertised rate that you come across with personal loans is usually only available to people with good credit.
Personal loans also come with origination fees. The typical origination fee seen in most personal loans ranges anywhere between 1% to 6% of the amount borrowed. The purpose of the origination fee is to cover the cost of processing the loan. It may either be taken out of the amount given to you or rolled into the loan. For example, if you take out a $10,000 loan and have an origination fee of 4%, you will pay $400.
Another disadvantage of taking out a personal loan is that you could potentially be penalized for paying it off early. Some loans have a prepayment penalty which is charged to you if you pay the balance off prior to the end of the loan term. As you are shopping for personal loans, watch out for prepayment penalties. The larger the loan amount, the more fees.
Your payment each month, as well as your loan term, are fixed. This can be seen as a hurdle if you are used to paying small minimum monthly payments. Fixed payments can be a plus to other borrowers but if your personal loan has a monthly payment if $410 for 72 months, the lender can sue you if you are late or you miss any payments.
Finally, personal loans attract scammers. Make sure that you take extra precautions to make sure that your lender is legit. For example, you may come across different lenders that may ask you to provide them with a prepaid debit card. They will claim that it will be used as collateral or for loan fees. They mostly prey on people that have bad credit and are looking for a personal loan because no other bank will approve them. Be sure to check with the Better Business Bureau prior to applying with a lender if you are unsure of their reputation.
Personal loans have both pros and cons. They can be beneficial for paying off debt and building or re-building the health of your credit. You may also need to take out a personal loan to pay for a vacation or other expenses. On the downside, a personal loan can cause you to incur more debt than you can manage. They may also not be good if you have poor credit because you will end up with a higher interest rate. Do your research and try to compare different lenders prior to taking out a personal loan.