Personal loans are rising in popularity due to their ease and convenience — here’s what you need to know.
The use of personal loans hit an all-time high in 2020, but there is still a lot of uncertainty about the use of this financial tool. While personal loans can be used in a multitude of ways, it’s important to know when the benefits of one outweigh other options and which use cases are best suited for this powerful financial tool.
“Personal loans are unsecured—you can use them for just about anything,” notes Todd Lunsford, president of Fin-tech company Rocket Loans. “They are typically convenient, fast, and ultimately provide the discipline required to pay off the debt in a relatively short period of time.”
Personal loan basics
There are specific use cases where personal loans make the most sense. “We encourage clients to use the right loan for the right purpose,” says Lunsford. “While a personal loan can be used for almost anything, it usually doesn’t make sense to finance something that is collateralized, like a car, boat, or RV.”
That’s because personal loans are unsecured (with no assets used as collateral) and generally have higher interest rates than loans secured with collateral. Personal loans generally offer interest rates between 5 and 36 percent depending on various factors. But a personal loan makes sense for specific use cases—like debt consolidation or home improvements.
“People can get trapped in credit card debt,” notes Lunsford. “Small, minimum monthly payments aren’t going to pay down the principal, and credit cards almost always use variable interest rates, so even if you pay each month, the balances increase.” In contrast, a personal loan can give a client the money they need with a fixed payoff schedule.
When to use a personal loan
Personal loans make sense for debt consolidation because they come with a fixed interest rate that’s usually less than credit cards, and the specific term (typically 36-60 months) helps pay off the debt in a steady, disciplined fashion. “A personal loan is a chance to get disciplined about credit card usage,” says Lunsford, although he notes that the key to success is to avoid building up new balances. “And keep in mind most personal loans have NO prepayment penalties–if you make extra payments or pay your loan off earlier, it will definitely save you additional interest.”
Personal loans also offer advantages for financing home improvement projects. Because there is no collateral, the loans are separate from your other debts and property, and the fees associated with personal loans are often much lower than other loans.
But one of the most important advantages of a personal loan is speed. “Compared to other options, a personal loan is FAST,” notes Lunsford. “In many cases, you can have funds in your bank account in the same or next business day as applying.” And lenders make personal loans as convenient as possible—Rocket Loans, for example, lets you complete the application online, and the loan is usually funded that day—without the back and forth typical of dealing with a bank..
Personal loan benefits
Determining whether a personal loan is the right option requires a bit of research. “Compare the total cost of different loan options,” advises Lunsford. “In many cases, the interest rate on a personal loan seems higher than some options, but a lower rate combined with making minimum payments usually costs you more. It really is the total cost of the loan that matters the most. A good way to determine if a personal loan is right for you is to get a quote for a personal loan – typically, you can obtain a free quote online with no impact on your credit score (please review a specific lenders disclosure about this point to make sure)—reputable lenders will disclose the total cost of the loan, including all interest, fees, and principal payments.”
Lunsford notes that personal loans can be very beneficial in other ways—paying them off can build up your credit score even as you eliminate debt. “As long as you’re using a personal loan responsibly, and are committed to repaying the loan on-time,” he says, “you’re in great shape.”