When Is Taking Out a Personal Loan a Good Idea?

what is a personal loan

A few years ago, I was walloped with medical bills. I didn’t qualify for a hospital payment plan and the bills exceeded my savings, so using credit cards were my only option.

Soon, I ended up with thousands in debt and was paying 14% in interest. The high rate made it more difficult to pay down my balance and get ahead.

I paid off my credit card debt using a personal loan — with a much lower interest rate of 8% — so that more of my monthly payments went toward the debt’s principal amount, rather than interest. If I keep on my current payment schedule, I’ll pay off my debt five years earlier than if I had stuck with the credit cards.

If you’re struggling with debt like I was, you might have heard about consolidating your debt with a personal loan. But what is a personal loan, and how do you get one?

What is a personal loan?

Personal loans can help you fund a large expense or consolidate debt. You can use them for almost anything you want, such as a big wedding or home renovations. However, many lenders don’t allow you to use a personal loan for education expenses.

Personal loans are unsecured debt, meaning that you can take out a loan without offering collateral. That’s a big difference from secured debt, such as a car loan. If you fall behind on your payments on a secured loan, the lender can seize the collateral — such as your vehicle — to recoup their money.

Because personal loans have no collateral or guarantee behind them, they typically have higher interest rates than secured loans. However, personal loans usually offer better interest rates than credit cards.

When should you use a personal loan?

Although personal loans tend to have lower interest rates than credit cards, they’re still a form of debt and should be used carefully.

Borrowing money to pay for a luxurious vacation or a big purchase can be a costly mistake. It’s often better to delay the expense until you can save enough to pay for it in full.

However, personal loans do have their uses. If you have high-interest credit card debt, they can be a big help.

Adam Hagerman, a certified financial planner, said using personal loans to better manage credit card debt is common. “The majority of personal, unsecured loans I see are for debt consolidation,” he said.

A personal loan can help you save money and pay off your debt sooner through a process known as debt consolidation. You take out a personal loan for the amount of your credit card debt and use it to pay off the balance. Rather than making payments on the credit card, you’ll have just one easy payment for your personal loan.

Even better, using a personal loan to consolidate your credit card debt can be a smart way to save money. “In my opinion, [consolidating credit card debt] is one of the only reasons to consider a personal loan” said Hagerman.

According to the Federal Reserve, the average interest rate for credit cards is over 13%. If your credit card balance was $10,000 and you only made the minimum payments, it would take over 15 years to pay off the card. Plus, you’d pay back more than double what you originally charged; with interest, you’d pay a total of $23,250.

By contrast, personal loans can have much lower interest rates. The average rate is approximately 10%, though some lenders offer rates as low as 5%.

If you took out a five-year personal loan with a 10% interest rate and used it to cover your credit card balance of $10,000, you’d pay back just $12,748 in total. That’s a savings of over $10,000 — and you’d be debt-free 10 years sooner.

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Although Hagerman believes a personal loan can be a good idea for debt consolidation, he also recommends looking at how you got into debt in the first place so you can treat the root cause of the problem.

It’s crucial to understand how and why you accrued debt. Was it a spending issue? A sudden emergency? An income issue? By tracking your income and expenses, you can identify the cause and finally end the debt cycle once and for all.

How to take out a personal loan in 5 easy steps

If you’ve decided that a personal loan is a smart option for your situation, here’s how to apply for one:

  1. Check your credit score: Most lenders will look at your credit history as part of your application. The better your credit score, the lower the interest rate on your loan. Knowing your score ahead of time will help you avoid any surprises.
  2. Compare lenders: Come up with a list of lenders that offer personal loans. If possible, get an estimate from each to find out what interest rate you qualify for and possible repayment terms. By looking at multiple lenders, you can ensure you get the best deal.
  3. Collect necessary documents: When you start the application process, the lender will ask for documentation of your income, your driver’s license number, and your Social Security number.
  4. Complete the application: Many lenders allow you to complete the application process online. However, you can also visit your local bank or credit union in person to apply for a personal loan. In either case, the lender will walk you through the application process.
  5. Receive a decision: In most cases, you’ll get a decision from the lender within minutes. If you accept the loan, you can receive the money in just a few days.

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Personal loans are great (sometimes)

What is a personal loan and why are they so attractive? They’re appealing because they offer a lower-interest way to make a big purchase. However, they’re still a form of debt and should be used with caution.

If you’re ready to kick your credit card debt to the curb, this credit card consolidation guide can help you tackle your debt today.

Melanie Lockert contributed to this article.

Interested in a personal loan?

Here are the top personal loan lenders of 2018!
LenderRates (APR)Loan Amount 
1 Includes AutoPay discount. Important Disclosures for SoFi.

SoFi Disclosures

  1. Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi’s underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Finance Lender Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org)
  2. Personal Loans: Fixed rates from 5.49% APR to 14.24% APR (with AutoPay). Variable rates from 5.29% APR to 11.44% APR (with AutoPay). SoFi rate ranges are current as of December 1, 2017 and are subject to change without notice. Not all rates and amounts available in all states. See Personal Loan eligibility details. Not all applicants qualify for the lowest rate. If approved for a loan, to qualify for the lowest rate, you must have a responsible financial history and meet other conditions. Your actual rate will be within the range of rates listed above and will depend on a variety of factors, including evaluation of your credit worthiness, years of professional experience, income and other factors. Interest rates on variable rate loans are capped at 14.95%. Lowest variable rate of 5.29% APR assumes current 1-month LIBOR rate of 1.34% plus 4.20% margin minus 0.25% AutoPay discount. For the SoFi variable rate loan, the 1-month LIBOR index will adjust monthly and the loan payment will be re-amortized and may change monthly. APRs for variable rate loans may increase after origination if the LIBOR index increases. The SoFi 0.25% AutoPay interest rate reduction requires you to agree to make monthly principal and interest payments by an automatic monthly deduction from a savings or checking account. The benefit will discontinue and be lost for periods in which you do not pay by automatic deduction from a savings or checking account.

2 Important Disclosures for Citizens Bank.

Citizens Bank Disclosures

  1. Personal Loan Rate Disclosure: Fixed interest rates range from 5.99% – 16.24% (5.99% – 16.24% APR) based on applicable terms and presence of a co-applicant. Lowest rates shown are for eligible applicants, require a 3-year repayment term, and include our Loyalty and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty Discount and Automatic Payment Discount disclosures. Subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change.
  2. Loyalty Discount: The borrower will be eligible for a 0.25 percentage point interest rate reduction on their loan if the borrower has a qualifying account in existence with us at the time the borrower has submitted a completed application authorizing us to review their credit request for the loan. The following are qualifying accounts: any checking account, savings account, money market account, certificate of deposit, automobile loan, home equity loan, home equity line of credit, mortgage, credit card account, student loans or other personal loans owned by Citizens Bank, N.A. Please note, our checking and savings account options are only available in the following states: CT, DE, MA, MI, NH, NJ, NY, OH, PA, RI and VT. This discount will be reflected in the interest rate and Annual Percentage Rate (APR) disclosed in the Truth-In-Lending Disclosure that will be provided to the borrower once the loan is approved. Limit of one Loyalty Discount per loan, and discount will not be applied to prior loans. The Loyalty Discount will remain in effect for the life of the loan.
  3. Automatic Payment Benefit: Borrowers will be eligible to receive a 0.25 percentage point interest rate reduction on their Citizens Bank Personal Loan during such time as payments are required to be made and our loan servicer is authorized to automatically deduct payments each month from any bank account the borrower designates. If our loan servicer is unable to successfully withdraw the automatic deductions from the designated account two or more times within any 12-month period, the borrower will no longer be eligible for this discount.
7.39% - 29.99%$1,000 - $50,000Visit Upstart
5.29% - 14.24%1$5,000 - $100,000Visit SoFi
8.00% - 25.00%$5,000 - $35,000Visit Payoff
5.99% - 16.24%2$5,000 - $50,000Visit Citizens
5.99% - 35.89%$1,000 - $40,000Visit LendingClub
5.25% - 14.24%$2,000 - $50,000Visit Earnest
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Our team at Student Loan Hero works hard to find and recommend products and services that we believe are of high quality and will make a positive impact in your life. We sometimes earn a sales commission or advertising fee when recommending various products and services to you. Similar to when you are being sold any product or service, be sure to read the fine print, understand what you are buying, and consult a licensed professional if you have any concerns. Student Loan Hero is not a lender or investment advisor. We are not involved in the loan approval or investment process, nor do we make credit or investment related decisions. The rates and terms listed on our website are estimates and are subject to change at any time. Please do your homework and let us know if you have any questions or concerns.