Personal loans can be taken out for just about anything: debt consolidation, medical bills, a ballooning wedding budget. It’s this flexibility that makes personal loans both appealing and potentially dangerous for the borrower.
Whatever your reason for getting a personal loan, if you don’t have a plan for how to pay it back, you could be on the hook for thousands of dollars of high-interest debt. A late payment — or worse, a defaulted loan — could put you in bad standing with credit bureaus, making it harder to take out a credit card or rent an apartment someday.
Before taking out a personal loan, ask yourself: Can I afford to take on debt? Am I getting the best deal? What would I be giving up by taking on debt? Would a loan be necessary now?
Here’s what you need to know about personal loans, and what you should — or shouldn’t — use them for.
What Is a Personal Loan?
A personal loan is, as the name implies, a fixed installment loan that can let you quickly access cash for personal use. Most personal loans are unsecured, meaning they’re not backed by collateral. Unsecured loans tend to have higher interest rates than secured loans since they’re riskier for the lender. However, since the borrower isn’t at risk of losing their assets — like their house or car — if they fall behind on payments, unsecured loans are generally better for the borrower.
Beyond basic limitations outlined by your loan provider — many personal loan companies don’t allow their personal loans to be used for business purposes, investments, real estate, or tuition — you can use a personal loan for just about anything. Some of the most common uses for personal loans include debt consolidation, home repairs, and emergency expenses. However, it’s important to remember that while personal loans can give you access to quick money, it’s far from free money. Interest rates for personal loans depend on your credit score and loan terms, and can get quite high for those with poor credit. Before taking out a personal loan, make sure that it’s truly necessary and you have a plan for paying it off. And depending on your needs, it may be worth looking into alternate options like a balance transfer credit card or home equity loan.
When Should I Get a Personal Loan?
Consolidating credit card debt is one of the most popular use cases for personal loans. Anuj Nayar, financial health officer at LendingClub, says, “When we first started in 2008, we positioned ourselves as just a better way to get a loan for whatever you wanted. It could be home improvements, vacations, whatever. What we found was that customers were overwhelmingly coming to us for debt consolidation — and the vast majority of that was people looking to refinance credit cards to get themselves back on a path to financial health.”
At an average APR of 15%, with some cards exceeding 25%, credit card debt can be expensive and overwhelming. It’s a difficult treadmill to get off, so personal loans can be beneficial. To cover the debt, you take out a fixed amount of money at a fixed interest rate, and you pay a fixed monthly payment.
With proper budget planning and automated payments in place, managing personal loan debt can be simpler than managing credit card debt, the interest rate of which is usually variable. For comparison, personal loan interest rates can range between 5% to 36%, depending on your creditworthiness and the terms of the loan. But to be clear, since loan interest rates can easily exceed the rates on higher credit cards, this move only makes sense if you can get a personal loan with a lower interest rate than your credit card APR.
If you have good credit, a balance transfer credit card might be an alternative worth looking into. Certain cards offer a 0% APR for an introductory period, typically 12 to 18 months, and allow you to transfer your existing balances from other cards for a one-time fee. If you’re looking to consolidate credit card debt, a balance transfer card could work as the equivalent of a personal loan with 0% interest, as long as you pay off the balance before the introductory period ends. Otherwise, you’ll be on the hook for high credit card APRs.
If you are having issues with managing debt, we recommend getting in touch with your creditor first. Oftentimes lenders are willing to work with you in times of hardship. Whether it’s deferring payments, negotiating a lower interest rate or monthly payment, or waiving fees, getting an accommodation from your lender will make it easier on you and your credit score in the long run. You may also be able to find help from free credit counseling services, which won’t provide you with money directly but can help you get your finances in order.
Home improvement, whether it’s a renovation or repair, is another common reason to take out a personal loan. In the event of a leaking roof, termites, or utility issues, it may behoove you to get a personal loan to help with the significant up-front costs and pay back the expense over time. However, if you’re thinking about knocking out walls for an open floor plan or digging up the backyard to build a pool, consider whether this is an important reason to take on potentially tens of thousands in debt and what a reasonable loan amount would be.
“Don’t overborrow,” says Farnoosh Torabi, finance journalist and host of the “So Money” podcast. “With any kind of debt that you take on, especially a personal loan, you don’t want it to be more than 5 to 10% of your monthly budget.”
And again, it’s important to have a plan — and the means — to pay back a loan, especially for nonessential home repairs that could potentially be put off for the time being. It might make more sense to take out a loan for a long-planned home repair if you’re confident in your financial stability for the near future.
If you need to borrow a large amount for home improvements, you may be able to find higher loan values and better interest rates with a home equity loan, home equity line of credit (HELOC), or cash-out refinance. These options all allow you to tap into your home equity for cash access, but do so in different ways. However, be aware that they all require using your house as collateral, which may be riskier than an unsecured personal loan.
First off, the Funeral Consumers Alliance, a nonprofit consumer advocacy organization, does not recommend taking out a loan to finance a funeral, due to the high interest rates these loans often come with.
That said, the average cost of a funeral was $7,360 in 2017, according to the National Funeral Directors Association. It’s a staggering amount of money for most people, but especially those in the midst of grieving a loved one and perhaps navigating financial uncertainty elsewhere. If a funeral cannot be paid for out of pocket or with life insurance, then surviving family members might find themselves looking at personal loans as a measure of last resort.
We agree that personal loans should be an absolute last resort when facing funeral costs, but if you believe they are necessary for your circumstances, you should at least request loan estimates from multiple lenders to get a rate and terms that will cause as little additional hardship down the line as possible.
When Shouldn’t I Get a Personal Loan?
According to the 2020 WeddingWire Newlywed Report, couples spend $30,000 on average on their wedding. The cost has increased each year as nice-to-haves — like bridesmaid robes, wedding favors, and day-after brunches — morph into essential expenses. Many services, such as catering and venues, automatically cost more if the word “wedding” is uttered once, so it’s a no-brainer that people may want to get a personal loan to manage the rising costs.
We do not recommend taking on debt to pay for a wedding, though. Incurring $30,000 in debt at the start of a marriage will add unnecessary pressure to this new life stage and limit your ability to invest in a home, savings, or retirement accounts.
Some people use personal loans to pay for travel expenses, such as flights, hotels, and excursions, and pay off the debt in the months or years after. Before you call your bank to get funding for a trip to Venice or Lake Tahoe — it’s important to note that these loans can be expensive and charge high interest for those with poor credit.
It can also be a rude awakening to come back from vacay with a large bill and no way to pay it back. Nayar from LendingClub says that personal loans are best used for emergencies or financial recovery, not to “further an Instagram lifestyle.”
Personal loans can be used to consolidate all kinds of debt, including student loans (though some lenders may have restrictions against this). However, it’s generally not recommended, unless you have student loans with unusually high interest rates. Most student loans have rates lower than personal loans, and when you replace your student loan into a personal loan, you lose access to deferments, forbearances, and other types of payment arrangements. This is especially true if you have federal student loans, which offer many protections that private lenders do not.