In this article:
Personal loans are notable for their versatility. The funds can be used for many purposes, from dealing with the past to planning for the future and virtually everything in between. Yet while these products can help you achieve your goals, they're not always the best solution. Before pursuing a personal loan, learn more about what you can use them for—then decide if you should start filling out an application.
How Personal Loans Work
Personal loans are credit products, and many banks, credit unions and online lenders offer them. These loans are typically unsecured, which means you don't have to provide any collateral. All come with terms, including:
- The number of months or years you have to repay the loan
- The interest rate, which is what the lender charges you to finance the loan
- The monthly payment
Some loans come with origination fees, which might be anywhere from 1% to 8% of the loan amount. The fee for a $5,000 loan, for example, could range from $50 to $400. The fees will be tacked on to the principal, and interest will be calculated on the total.
Once you apply for a personal loan, the lender will check your credit history and credit scores, and analyze your cash flow to determine whether you can handle the payments. If you're approved, the money may be available to you within minutes or days, depending on the lender.
What Can I Use a Personal Loan For?
You can use your loan funds for a variety of things, and some are more financially healthy than others. Among the vast array of options:
Debt consolidation: If your current batch of creditors are charging you a high interest rate, a personal loan to consolidate the old debts under one lower rate can work to your advantage, especially if it doesn't have an origination fee. One caveat, though: If you're consolidating credit card debt, those accounts can be used again. Those credit lines can be tempting, so make sure you resolve not to use your cards while you pay off your loan—otherwise you could be back in the same situation, but with an even higher pile of debt.
Medical bills: Personal loans can help you when you find yourself with mounting medical bills. Because these liabilities can get very high, though, try to negotiate the bills down first. Your health care provider may give you a discount. If not, you may be able to pay in installments at no additional cost so you don't have to borrow money and thus pay interest. If these strategies don't work, a personal loan may be what you need to pay off that debt.
Student debt: Although you can repay a student loan with a personal loan, it's usually not wise. Student loan interest rates are usually lower than other loans, and the payments on a new loan will probably be higher. Also, you'll forfeit the opportunity to obtain deferments and forbearances, flexible payment arrangements, and the potential to have all or some of your debt forgiven if you pay off your student loan with a personal loan.
Collection agency debt: If collectors are breathing down your neck, satisfying the bad debts with a personal loan can make sense. Not only will the calls cease, but your credit rating may start to improve. The problem? Many collectors don't charge interest, but lenders do. And if your credit rating is low because of the collection activity, the interest rate on your personal loan will probably be high.
Tax debt: Owing the IRS can be scary and expensive. Deleting the debt with a personal loan is an option, but be sure to find out if an IRS installment agreement is better first. Consider the interest rate and fees on your personal loan versus interest and penalties you'd accrue as you pay your installment agreement to determine whether this is a good idea.
Necessary home repairs: Borrowing money to fix something crucial in your home (such as taking care of termite damage or a damaged roof) is reasonable and prudent. Installing custom stained glass windows? Not so much. Don't conflate need with desire. Also, check to see if repair costs can be covered by your homeowners insurance. After all, that's why you pay for it.
Repaying family or friends: If you're indebted to someone who has helped you out with a loan but now you can't pay them back, your relationship is at risk. A personal loan can come to the rescue, but communicate with that person first. Maybe you can work out new payment arrangements that will be mutually satisfactory. While a personal loan may help you feel less guilt toward someone who has helped you financially, transferring this debt to a personal loan could end up costing you more in the long run.
Helping a loved one: Conversely, when a destitute friend or family member approaches you for financial assistance, you may be so moved by their plight to take out a loan to help. If you're willing to assume the costs and can easily meet the payments, that's your prerogative, but think long and hard. If you fall behind, you'll be the one needing assistance.
Wedding costs: A wedding can be wildly expensive. Without savings to pay for your big day, a personal loan may seem like a great idea. Just review the pros and cons first. The interest rate may be lower than if you used a credit card, and a well-managed loan can boost your credit rating, but you may be tempted to overspend. And do you really want to start your marriage in the red?
Divorce: On the flip side, many marriages don't work out the way people hope. The cost to split can exceed the money in your bank account. According to a study by legal publisher Nolo, the average divorce costs around $15,500. If you don't have enough to cover the lawyers' fees and court costs, a personal loan can come in handy.
Vacation: Can you pay for a fabulous vacation with a personal loan? Yes. Should you? Probably not. Traveling is wonderful, but it's best to use a portion of your paycheck or save for the trip instead. Then you can use a credit card for purchases and pay the balance in full, so you can get your rewards while not paying financing fees.
Vehicle financing: Because car loans are secured by the vehicle, the interest rates tend to be lower than those on unsecured personal loans. Therefore, unless you can score an unusually low rate, an auto loan is probably preferable. The only alluring aspect of using a personal loan is that it doesn't require a downpayment, and auto loans typically do.
Expensive consumer goods: Computers, mattresses, jewelry, appliances … There is an endless number of things you can buy. If you don't have the cash upfront, the funds from a personal loan can bring them home. To know whether it's a wise thing to go into debt for, ask yourself if you really need the item now. If you don't, start socking cash away for it instead.
Moving expenses: The cost to have professional movers box up your things and transport them to your new abode can be thousands of dollars. If you can't do it yourself (or assemble a group of friends who can pitch in), a personal loan can come to your rescue.
Funeral costs: Taking out a personal loan for a loved one's funeral is a personal choice, but you should consider your ability to repay the loan before making this decision.
Pets: When you bring an animal into your life, you're assuming a serious responsibility. Major veterinary bills could be in your future, and a personal loan can help you pay for them when you're in a pinch. What's not recommended: purchasing a pet with the loan. You should be able to afford the animal, and having to go into debt to acquire a pet is a sign that you can't.
A small business: Personal loans are not designed for business purposes, though some entrepreneurs try to use the funds for launching or operating costs. Small business loans or credit lines are the more appropriate products, so if you're tempted to augment those funding sources with a personal loan, first seek advice from a professional who can guide you to the right choice.
The holidays: You want to spread joy, give generous gifts and celebrate the season in style, so why not take out a personal loan for it all? Because it's economically foolhardy. Added fees and interest increase the cost of all those purchases, and the monthly payments will erode the amount of money you have for essential bills.
What Credit Score Do I Need for a Personal Loan?
As with any credit product, personal loans with the lowest interest rates are available to people with the highest credit scores. Check your FICO® Score☉ before applying. If it's in the 670-to-850 range, the lender will consider your credit rating as good to excellent. In that case, the least expensive personal loan options will be open to you.
Many lenders do offer personal loans to people with lower credit scores, but the interest rates will rise as your scores dip. The difference in the loan's ultimate cost can be dramatic. For example, if you take out a loan of $5,000 and it has a repayment term of three years:
- A rate of 5% will cost you $395 in interest
- A rate of 15% will cost you $1,240 in interest
- A rate of 25% will cost you $2,157 in interest
Keep in mind that individual lenders set their own interest rates, so you may get a better or worse rate with the same credit score. Review many lenders' rates before deciding on one.
Weigh the Pros and Cons
Clearly, personal loans can be both beneficial and problematic, so always weigh the pros and cons of borrowing money prior to submitting an application. Will it solve your troubles, enhance your life and create a better financial picture? Can you easily afford the monthly payments and are the fees and financing costs reasonable? If all your answers are affirmative, taking out a personal loan may be a positive decision.
Personal Loan Calculator
†The information provided is for educational purposes only and should not be construed as financial advice. Experian cannot guarantee the accuracy of the results provided. Your lender may charge other fees which have not been factored in this calculation. These results, based on the information provided by you, represent an estimate and you should consult your own financial advisor regarding your particular needs.