Personal Loans: Five Things to Consider Before You Borrow
If you’re struggling financially, a personal loan might seem like an option for relief. But it’s important to know the pros and cons of borrowing money or taking on debts. [Duration- 1:57]
Reading time: 4 minutes
If you're struggling to make ends meet and you experience a financial emergency, you might consider taking out a personal loan to help you get through the tough time. But before you borrow, it's important to understand how personal loans differ from other loans and what they might mean for your finances.
What is a personal loan?
A personal loan is a line of credit that can be used at your discretion. People commonly use them to cover home repairs, medical bills and other unexpected one-time expenses, to pay for weddings and other major life events or to consolidate credit card balances and other existing debt.
Unlike mortgages or car loans, personal loans are unsecured, meaning you don't put up collateral to obtain one and if you fail to pay back what you borrow, your lender can't automatically seize your property. However, this doesn't mean personal loans are cost- or consequence-free.
Are personal loans right for me if I'm struggling financially?
Perhaps. If you have income stability and are confident you can pay back what you owe in a timely manner, a personal loan might work for your financial situation. However, it's generally unwise to treat a personal loan as a solution if you are unemployed or otherwise struggling financially.
You should be especially wary of payday lenders, as they will often charge $15 to $30 per $100 borrowed, which could translate into an interest rate between 300% and $500%. Other types of short-term personal loans may be available at far better interest rates or with lower (or no) fees.
If you believe a personal loan might be right for your unique financial situation, there are a few things to consider:
- Do your research and compare lenders. It's more important than ever to shop around when looking for a personal loan. If you're initially rejected, don't get discouraged. Lenders have different qualifying standards, and you may still be able to get approved elsewhere.
- Watch out for scams. Be wary of any lender that guarantees approval before checking your credit or asks you to send money before securing the loan. If a lender seems suspicious for these or other reasons, you can check their background with the Better Business Bureau or the Consumer Financial Protection Bureau.
- Reconsider taking out a personal loan for nonessential expenses. Historically, people have taken out personal loans for things like a wedding or home renovation. With a stable income and a plan to pay the loan back, this can be a good way to cover big costs up front.
- Consider debt consolidation. If you have significant credit card debt, now might be a good time to look into debt consolidation. This is a form of debt refinancing where you combine multiple balances into a single loan, ideally with a lower interest rate. In this case, you would use a personal loan to pay off your high-interest credit card debts.
Although personal loans can be used to consolidate many kinds of debt, they're generally not a good idea for student loans, which tend to have lower interest rates. You also potentially have more repayment options with student loans. Especially during the Covid-19 pandemic, many creditors are offering forbearance plans that you should research before deciding to use a personal loan to consolidate student debt.
- Make a plan to pay back the debt before you apply. No matter your reason for taking out a personal loan, it's important to have a repayment plan before you apply. Consider these questions:
- Do you have a stable income?
- Are you confident your income will remain consistent in the coming months?
- Do you have existing loans you're already repaying? If so, will you be able to manage new debt?
In some cases, personal loans can help you pay for unexpected life events or better manage existing debt. However, taking on debt of any sort is always a big decision, so make sure to understand the pros and cons before applying for a personal loan.