What is a Loan?

A loan is money, property, or other material goods given to another party in exchange for future repayment of the loan value or principal amount, along with interest or finance charges. A loan may be for a specific, one-time amount or can be available as an open-ended line of credit up to a specified limit or ceiling amount.
The type of borrowing most people know best is credit cards, which are a form of revolving debt. They give you access to a pool of cash that you can dip into as needed. You can take as long as you like to pay off this debt, as long as you meet the minimum payment each month, and the interest rate is likely to vary over time.

The pros and cons of personal loans

If you need extra cash to pay for home improvements, a wedding or to consolidate high-interest debt such as credit cards, you might want to consider a personal loan. Used wisely, an unsecured personal loan can fill a void in your budget without risking your home or other assets.

Advantages of personal loans

People take out personal loans for a variety of reasons. The most popular ones include :

1. They are versatile

Unlike a car loan, a mortgage or a student loan, a personal loan can be used for many purposes. You can use it to pay for car repairs, medical bills, a dream vacation, to consolidate credit card debt — pretty much whatever you need. However, just because you can use a personal loan for mostly anything doesn’t mean you should. Know the top reasons to use a personal loan.

2. Interest rates are decent

Personal loan rates are favorable compared with rates on credit cards. Federal Reserve figures for Q3 2019 show that the average interest rate on a 24-month personal loan is 10.36 percent, while the average rate on a credit card is 16.97 percent. For the most creditworthy consumers, personal loan rates hover in the range of 6 to 7 percent.

3. They are good for debt consolidation

One of the most popular uses of personal loans is to pay off higher-interest credit card debt.
“You may be able to lower your monthly payment and interest rate,” says Kathryn Bossler, quality assurance specialist at GreenPath Financial Wellness, a Michigan-based nonprofit that helps people through financial crises.

4. A variety of lenders offer them

Along with traditional banks and credit unions, you can borrow personal loans at online banks, such as Discover; online nonbank lenders, such as SoFi; and peer-to-peer lenders, such as LendingClub.

5. Excellent credit is not required

It’s possible to get a personal loan with bad credit. Some lenders cater to borrowers with less-than-great credit. Just know that you’ll pay higher rates, which can exceed 35 percent.

6. Monthly payments stay the same

Interest rates on personal loans are fixed, so your payment is the same every month.
“One of the things I like is that it gives you a clear beginning and end to knocking out your debt,” says J.J. Montanaro, a certified financial planner with USAA. “You can see the light at the end of the tunnel.”

7. You can borrow the amount you need

Whether you need a few thousand dollars or $100,000, you can find a loan with limits that fit your needs. Again, a lot depends on your credit score.

8. Loan approval is quick

While mortgage and home equity loans can take at least a month to close, it’s possible to apply for a personal loan online and have an answer the next day or within a few days. If you are approved, the money typically is deposited into your bank account within a few days.

9. You have enough time to pay it off

Unlike highly risky payday loans, personal loans give you a reasonable amount of time to repay. Terms can range from a year to seven years, depending on your lender and your credit.

Disadvantages of Personal Loans

Despite their benefits, personal loans aren’t always the best way to borrow money. Here are a few of their drawbacks:

1. Fixed Payments.

When you borrow money with a credit card, you can take as long as you need to pay it back. A personal loan, by contrast, has fixed payments that must be made on time. If you don’t meet these payments, the lender can seize your collateral if it’s a secured loan or sue you for nonpayment if it’s an unsecured one.

2. Higher Rates Than Some Loans.

For borrowers with good credit, personal loans typically offer lower interest rates than credit cards. However, for those with poor credit, a personal loan could cost as much as a credit card loan or more. Personal loans, especially unsecured ones, can also cost more than other types of installment loans, such as home equity loans.

3. Origination Fees.

In addition to the interest, many personal loans come with an “origination fee” to cover the cost of processing the loan. This fee is typically between 1% and 6% of the amount borrowed. You must pay this full amount up front when you take out the loan, rather than paying it back over time as part of your monthly payment.

4. Prepayment Penalties.

When you borrow money with a credit card, you can avoid paying interest by simply paying off the full balance as soon as you can afford it. However, with a personal loan, that’s not always possible. Many banks charge you a prepayment penalty if you pay off your loan early so they can make up for the interest they’re missing out on.

5. Potential for Scams.

A final risk of taking out a personal loan is that not all loan offers are legitimate. Scammers sometimes offer fake personal loans applications in order to get hold of your personal information, which they use for to steal your identity. In some cases, they also charge you a fee up front to initiate the loan, then disappear with the money. This is known as an advance-fee scam.