Personal loans can seem like ‘easy money’ if you’re struggling, or are considering a large purchase. How do you know whether you’re making a sound decision taking out a loan, however, and when should you rather look for alternate sources?
What is a Personal Loan?
Personal loans are a lump sum you apply for that will be deposited to your bank account. You will repay the amount (plus a pre-decided interest amount) over a set amount of months. Typically, personal loans are unsecured, meaning you don’t put an asset up for collateral if you fail, but that doesn’t mean you should view it as ‘free money’. Remember, you’ll pay back a little (or a lot) more in interest than the initial loan!
Personal loans are often less expensive than credit cards, and may be faster to approve than some other forms of lending.
Pros and Cons of Personal Loans
So a personal loan makes sense if you need to quickly get cash together to pay for a necessary expense. That doesn’t mean they don’t have drawbacks, however.
Pros of Personal Loans:
- A lump sum of cash fast
- Lower interest rates than credit cards
- Typically no collateral
- Usually fast to approve in the loan cycle
Cons of Personal Loans:
- You are taking on debt and obligations
- Another monthly payment you must be able to meet, like a bill
- You will need to match eligibility criteria
- Fees and penalties can add up fast
What are Good Reasons for a Personal Loan?
Personal Loans are best used to finance projects that need a big upfront investment, but its long-term cost is affordable within your budget. This could include:
- Consolidation of more expensive debt
- Unexpected costs in an emergency that savings won’t cover
- Large purchases like equipment or appliances
- Education costs
While some people use personal loans for big-ticket things like holidays and vacations, this is always worth considering in the larger scheme of your personal finances.
When Shouldn’t You Take a Personal Loan?
So, the reasons we outlined above would all be a good reason to consider financing with a personal loan. Effectively, it’s a smart way to have your back covered in the face of unexpected large expenses. When shouldn’t you look at a personal loan, however?
Firstly, never use a loan to finance ‘fun’ activities. This includes hobbies and pastimes, online gaming, and other voluntary expenses. As Profit Squad says, this sort of discretionary purchase should only ever be made with money you can afford to lose. If you need to finance it, step away.
Obviously, if you can’t make the minimum loan repayment, it’s also not smart to onboard more debt. Or you may be in the enviable position where you have better financing options open to you. This is particularly relevant to education, vehicle purchases, and real estate, where someone with a solid credit rating may have better options to pursue. The lower your credit score, the less likely these are to be available to you.
Never put your long-term financial well-being at risk for a short-term benefit. Always evaluate why you are seeking the loan, and make sure it’s the best fit for the circumstances.
Personal Loans can be an incredibly useful tool for emergencies or making your budget stretch for larger purchases, but it should always be properly considered, and you should seek a product that meets your ability to pay without issue.
