When you need to borrow money, the first step is deciding how to do it. You might consider a credit card or a home equity loan, but a personal loan could also be a good fit. A personal loan is a way to get cash fairly quickly, and with an unsecured personal loan, no collateral is required. If you're curious about the most common reasons for personal loans—or how they work—here's what you need to know.
What Is a Personal Loan?
A personal loan is an amount of money you borrow from a bank, credit union, or online lender. Personal loans can be secured, meaning you need collateral to get approved, or unsecured. You repay a personal loan over time, typically with fixed monthly payments and a fixed interest rate, although some personal loans may have variable rates. The lender sets the amount you can borrow and the repayment terms.
Qualifying for a personal loan depends on several factors, including your creditworthiness.
The stronger your credit score, the more likely you are to be approved.
A higher credit score can also translate to a lower interest rate on a personal loan. Personal loan lenders can also take into account things like:
- Your income
- Total monthly debt payments
- Whether you rent or own your home
Using a loan calculator like the one below can help you get an idea of how much your monthly payments will be and the interest you'll pay over the life of the loan:
Personal loans, sometimes called signature loans, are a type of installment debt. With installment loans, you're able to access a lump sum of money, and the loan has a fixed payoff date. That's different from a line of credit or a credit card, which are types of revolving debt.
With revolving debt, you make payments against your balance monthly, which frees up room in your available credit limit. You can carry a balance from month to month or pay in full. Credit cards are usually open-ended, meaning you can continue charging new purchases and paying them off indefinitely. A revolving line of credit, such as a home equity line of credit, may only be open for a set period.
Good Reasons for Personal Loans When You Need to Borrow
There are several good reasons for personal loans versus other types of loans or credit when you find yourself in a borrowing situation. You might consider a personal loan for any of these scenarios:
- Consolidating debt
- Buying a car
- Paying for a wedding
- Taking a vacation
- Unexpected expenses
If you have multiple loans at high-interest rates, it can be difficult to pay them down when a large share of your payment goes to interest. Consolidating debts by using a personal loan allows you to roll them into a single debt. This combining of debts gives you just one payment to manage each month, versus several. And ideally, you also get a lower interest rate, which can save you money.
You can also use a personal loan to consolidate credit cards. Once you're approved, and loan proceeds are deposited into your bank account, you can go down the list and pay off your cards. Going forward, you'd make payments to the loan since your card balances are zero.
Running up new balances on your credit cards after paying them off with a personal loan could add to your debt. And, it could leave your budget stretched thin.
Buying a Car
A personal loan could also be helpful if you want to buy a car. Similar to consolidating debt, you'd get the loan proceeds, then write a check from your bank account to cover the cost of the vehicle. Aside from cars, you could also use a personal loan to buy boats, motorcycles, trailers, or recreational vehicles.
Pay for a Wedding
The average wedding costs more than $33,900 in 2019. If you don't have that kind of cash sitting around, a personal loan could save your big day. For instance, you could use a personal loan to cover deposits, pay the caterers and photographer, purchase a wedding gown or tuxedo, cover travel costs for friends and family if you're having a destination wedding, or pay for the honeymoon.
Take a Vacation
Even if you're not getting married, you may still want to get away. If you have a dream destination is on the pricey side, you could use a personal loan to cover your expenses. That includes your airfare or other travel costs to get there and back, hotel rooms or other accommodations, food, entertainment, souvenirs, and any additional costs that might crop up along the way.
More than half of Americans wouldn't be able to cover an emergency expense using savings. If you're still working on your emergency fund, or you have yet to start, a personal loan could help with any financial curve balls life throws your way.
Other Reasons for Personal Loans
These are some of the most common reasons for personal loans, but there are other ways to use them as well. For example, you might decide to use a personal loan to:
- Cover home remodeling costs
- Start a small business
- Help cover your child's study abroad expenses
- Pay a tax bill
- Cover medical bills
- Pay final expenses for a loved one
- Finance a move
- Cover legal fees
- Buy a tiny home
- Pay off student loans
The Bottom Line
Whatever the reasons for personal loans, there are several things to consider before getting one:
- What interest rate will you pay, and does the lender charge any fees?
- How much can you borrow, and what will your monthly payments be?
- Are there any personal loan alternatives that may be a better fit for your borrowing needs and budget?
Remember to compare lenders to see where the best personal loan terms can be found. And of course, read the fine print carefully before signing off on a personal loan to make sure you understand the repayment details and the cost of borrowing.