Personal Loans Pros and Cons

Because interest rates are so low right now, many people are considering getting personal loans. But is this a good choice? I can’t answer that question because I don’t know your specific situation.

Instead, I’m going to discuss some of the pros and cons you should consider before deciding whether or not to take out a personal loan.

In this discussion, I am not using the term “personal loan” to refer to payday loans or cash advance loans, which I consider to be scams, not loans. Instead, when I use the phrase “personal loan,”

I mean a loan from a reputable lender that is deposited directly into your bank account and on which you make fixed monthly principal payments with a small amount of interest.

If, after hearing the ins and outs of personal loans, you’re interested in taking one out yourself, you can check out Fiona, a reputable, free lender who compares interest rates and terms of personal loan lenders. and connects you with one that best suits your situation.

Advantages of personal loans

Pro #1: Credit Score Increase

By getting a personal loan, you can actually increase your credit score in three ways:

  • Improved payment history: Timely payments on your personal loan will have a positive impact on your payment history, which accounts for 35% of your credit score.
  • Decreased use of credit: Personal loans can also boost your credit score if you use your earnings to pay off higher-interest credit card debt. For example, if you have a single credit card with a credit limit of $5,000 and a balance of $4,000 (equals 80% usage of the credit card) but you are approved for a personal loan of $3,000, you can use that $3,000 to pay off part of your credit card balance, reducing your credit card usage to just 20%. Since credit card utilization accounts for about 30% of your credit score, using low-interest loans to pay off credit cards this way can dramatically improve your credit score.
  • Enhanced Credit Mix: Finally, if you only have revolving credit, such as a credit card, a personal loan can increase your credit score by increasing your credit mix, which accounts for 10% of your credit score.

Pro #2: Opportunity to consolidate debt

In fact, you can save money by taking out a personal loan to pay off higher-interest debt. For example, if you get a personal loan at 10% interest and use it to pay off a credit card at 20% interest, you’ll end up paying 50% less interest than you otherwise would.

Pro #3: Avoid using high-interest credit cards

In some cases, a personal loan can keep you from incurring higher-interest debt. How do you know if you have taken me away personal finance courseI highly recommend keeping an emergency fund to cover any unforeseen expenses.

However, if you don’t have an emergency fund and need to make a sudden payment, a low-interest personal loan can be a much cheaper option than a high-interest credit card.

Pro #4: You can invest the profits to earn more money

If you borrow money at a low interest rate and use it to invest in something with a high interest rate, a personal loan can really make you money.

I usually liken this to a mortgage on a rental property: You’ve borrowed money and you’re paying interest, but you’re earning rental income that more than covers those interest payments.

While this is a benefit of personal loans that I have used myself in the past, keep in mind that this strategy carries significant risk; There is always risk in investing, but that risk is amplified when you borrow money to invest.

Cons of personal loans

Scam #1: It Can Hurt Your Credit Score

While getting a personal loan can boost your credit score, it can also hurt your credit score in a number of ways.

  • Credit Extraction: First, your lender will likely pull your credit when you apply, which can temporarily take a few points off your credit score.
  • Decreased length of credit history: Second, a personal loan can reduce the length of your credit history, which accounts for about 15% of your credit score. Because the length of your credit history is calculated by averaging the amount of time you’ve had items on your credit report, adding a new personal loan can dramatically reduce the length of your credit history, negatively affecting your credit score. .
  • Bad payment history: Finally, as I mentioned earlier, payment history accounts for 35% of your credit score, so if you repeatedly miss payments on your personal loan, you may see a significant drop in your credit score.

Con #2: It can give you license to spend

A personal loan can cause you to spend irresponsibly. People are usually less reckless with their spending when they have very little money, so I keep very little money in my checking account.

However, if you suddenly see a large amount of money in your account, you may be tempted to spend in ways you might not otherwise.

Scam #3: Paying Interest

Personal loans come with interest that comes out of your pocket.

Con #4: Possible Fees

Many personal loan products charge additional fees, including non-refundable application fees, origination fees, prepayment penalties, and late fees. Therefore, before applying for a personal loan product, you should always ask the lender about all possible fees.

Should you get a personal loan?

I can’t decide if a personal loan is right for you. You yourself have to weigh the pros and cons and decide if the interest you pay for a loan is worth it.

If you’re going to use your loan to pay off higher-interest credit card debt, a personal loan may be a good option, as long as you make payments on time and don’t ruin your credit score.

On the other hand, if you are just looking for money to spend on a vacation or similar expenses, getting a personal loan is probably not a good option.

When it comes to consumption, I’m a big fan of delayed gratification; Using unborrowed funds is not only a smarter financial decision, but what you buy will also be much more satisfying if you worked hard and paid for it with your own money.

If you decide to get a personal loan, make sure you understand all the terms, conditions, and fees, as many personal lenders advertise low interest rates but then charge huge fees.

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