Maybe you’re looking for a way to pay down your holiday debt, cover the cost of a car repair or pay for your wedding. A personal loan can be a quick source of cash, typically without the high interest rates of a credit card or credit card cash advance.
“It’s certainly an option you don’t want to ignore,” says J.J. Montanaro, a certified financial planner with USAA.
Personal loans have become a fast-growing financing option for consumers, and demand continues to rise.
TransUnion found the number of personal loan accounts reached 19.5 million in Q2 of 2018, up 12.5 percent since Q2 of the year prior. In total, outstanding personal loan balances reached a high of $125.4 billion in Q2 2018.
The following is a breakdown of some of the pros and cons for those who may be considering taking out a personal loan.
The pros of personal loans
A personal loan can be a good way to consolidate existing debt, such as credit cards, says Kathryn Bossler, a financial counselor at the non-profit GreenPath Debt Solutions.
“You’re essentially refinancing. You may be able to lower your monthly payment and interest rate.”
As of February 2019, the last month for which figures are available, the Federal Reserve reported the average rate on a 24-month personal loan was 10.36 percent, while the average rate on a credit card that was assessed interest was 15.09 percent.
Some personal loans even carry rates as low as 6 percent or 7 percent for the most creditworthy consumers.
If you’re trying to pay down several credit cards, you may be able to roll all your bills into a personal loan, so you have only one monthly payment to keep track of, Bossler says.
Montanaro says that another advantage with a personal loan is you pay a set amount for a specific length of time. “One of the things I like is that it gives you a clear beginning and end to knocking out your debt. You can see the light at the end of the tunnel,” he says.
Pay back your debt in installments
With a personal loan, you borrow a certain amount of money for a certain period of time, and pay it back in regular monthly installments.
Sometimes, the loans are unsecured, which means you don’t have to put up collateral, like a house or car. The rate you pay is based on your credit history and credit score.
Along with traditional banks and credit unions, you also can find personal loans at online banks, such as Discover; online nonbank lenders, such as SoFi; and peer-to-peer lenders, such as Lending Club.
Expect a quick decision on whether you’re approved
The loans are also easy to apply for, compared with a mortgage or home equity line of credit, and you’ll get a quick decision as to whether you’re approved, Montanaro says.
If you are, the money will typically show up in your bank account within a few days.
If you need a way to pay for such things as an unexpected car repair or medical bill, or even finance a big type of expense (such as a wedding), a personal loan will often have a lower interest rate than a credit card advance.
The cons of personal loans
If you use the loan for debt consolidation, you need to remember “you’re not paying off debt, you’re just transferring it from one type of debt to another,” Bossler says.
And, if you transfer your credit card bills to a personal loan, there’s always the chance you might charge new debt on your credit cards. A personal loan “provides the opportunity to dig yourself out of a hole. It also has the potential to become a bigger hole,” Montanaro says.
Watch out for these downsides when looking to take out a personal loan:
You could be faced with high interest rates
Taking out a personal loan to consolidate debt can be useful, but if your credit score isn’t strong, get ready for hefty interest rates. That’s not to say taking out a personal loan won’t be worth it, but individuals with wavering credit should shop around for the best rate.
Oftentimes, the marketing material for personal lenders will advertise a low rate — but experts warn that this is usually the “best case scenario” for prime applicants and shouldn’t be expected while applying.
“You have to really be careful of reading the fine print,” says Theresa Williams-Barrett, vice president of consumer lending and loan administration for Affinity Credit Union. “What they try to sell you on is always the best case. You have to really find out how it applies to ‘me’ based on my credit score and my information. Be very careful while comparing.”
You’ll likely have to pay fees
Borrowing money isn’t free — and personal loans can charge from 1 percent to 4 percent (or more) of the total amount you’re borrowing, according Williams-Barrett. These origination fees are in addition to the interest costs that come with the loan.
Additionally, some lenders charge fees for prepaying the loan before its terms are up or for late payments. Williams-Barrett recommends taking a close look at all of the terms and conditions before accepting a personal loan.
The larger the loan, the more there could be additional fees,” Williams-Barrett says. “You have to be really careful [when] comparing.”
Borrowing brings opportunity of getting scammed
As with any financial product, scams run rampant with personal loans. There are some ways to spot a scam and to verify a potential lender, though.
“Consumers have to be really careful about what the fees are,” Williams-Barrett says. “And if somebody is asking them to pay ahead of time, they should do some research on that financial institution” to make sure it’s a legitimate lender.
To look up accredited lenders, search the Better Business Bureau’s website (BBB). Additionally, the Federal Trade Commission (FTC) requires lenders and brokers be registered in the states where they conduct business. You can access this information by checking the lender’s website or contacting your state attorney general’s office for further verification.