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There are many good reasons to take out a personal loan, including consolidating costly credit card balances and financing weddings or once-in-a-lifetime trips, but they are often most useful for less festive events, such as emergency home repairs or medical expenses.
You can use a personal loan—funds you borrow from a bank, credit union or online peer-to-peer lender without having to put up collateral—for just about anything. That flexibility adds to their appeal, as does the fact that the approval process is generally pretty quick: If your credit is good and the lender is satisfied by the income information you provide, the loan funds can often be deposited into your account within a week, or even less.
Here are some suggestions on when it makes sense to seek a personal loan—and a few instances where a personal loan probably isn't your best option.
When to Consider a Personal Loan
The list of potential uses for personal loans is nearly endless, but prime circumstances when you might want to consider taking one out include:
- Combining pricey credit card balances. If you're carrying high balances on multiple credit cards, they're probably costing you a lot in interest payments, and they're likely lowering your credit score as well. Using a personal loan to pay off your credit cards, a process known as debt consolidation, can let you simplify multiple bills into one, reduce your interest charges and improve your credit score.
- Emergency expenses. If your house needs a new roof in a hurry or your furnace goes kaput, you may be able to cover the costs on a credit card. But big-ticket repairs can lead to high card balances that hurt your credit score and rack up big interest charges. The same can be true of medical emergencies: An injury or illness that requires forking over your full annual deductible in one payment could overtax your credit cards, and related expenses that aren't covered by your health care plan can add up fast. Using a personal loan to help manage these expenses can take a little stress out of the situation.
- Personal events. When mounting a pricey one-off event like a wedding, golden anniversary gala or even in some cases a funeral, a personal loan can provide a ready pool of cash to help deposits and payments for caterers, florists, venue rentals and the like.
- Home remodeling. When making a major improvement to your home, such as a kitchen remodel or expansion of your master bathroom, financing options often come down to a choice between a personal loan and a home equity line of credit (HELOC). If your credit is solid and you've been in your home long enough to have sufficient equity, you may be able to get a somewhat better interest rate and a higher spending limit with a HELOC, but home equity loans carry the risk of losing your home if you're ever unable to make payments. If you prefer not to use your home as collateral, or if you've only been in the house a few years, a personal loan could be a great financing option.
When a Personal Loan Might Not Be a Good Idea
As flexible as personal loans may be, there are several purposes for which it doesn't make sense to use one:
- College tuition. Dedicated student loans make more sense than personal loans for financing college education for a few reasons:
- Interest rates, especially on government-backed student loans, tend to be lower than those on personal loans.
- While student loans typically don't require a first payment until some months after the borrower has completed their studies, personal loan repayment begins right away, with the first payment typically due one month after the loan is issued.
- While most personal loans are issued on a "no strings attached" basis, some lenders explicitly forbid using them for college expenses.
- Financing a car. Auto loan interest rates are typically lower than those on personal loans because the vehicle serves as collateral on car loans.
- Paying for vacation. Once-in-a-lifetime events such as a honeymoon getaway or a just-retired grand tour might be grounds for taking out a personal loan (provided you have the means to repay it), but most experts agree it's best to fund regular vacations by setting aside household funds, and to plan the scale of your getaway accordingly: Some years you may be able to jet to the islands; other years the budget might call for a road trip or stay-cation.
How to Get a Personal Loan
Applying for a personal loan is a fairly straightforward process, and many lenders now allow you to apply online, so you can (and should) check with multiple sources to try to shop for the best interest rates and fees. For each application, you'll need to indicate how much you want to borrow, and you'll need to submit information about your income, employment and, often, your outstanding debt and monthly expenses.
Most lenders will check your credit score and credit reports as part of their lending decisions, so unless you're in an emergency situation, it makes sense to review your credit reports and scores so you'll have an idea what the lenders see when looking at your application.
As with virtually all types of personal credit, personal loan lenders reserve their lowest interest rates for people with excellent credit scores. If your credit is fair to good, finding a personal loan at a low rate may be challenging, and if your credit is on the low end of the spectrum, you may need to take the time to build up your credit scores before you can qualify for a personal loan.
How a Personal Loan Can Affect Your Credit
When you apply for a personal loan, lenders typically will perform a hard inquiry on your credit report to review your credit history and check your credit score. This causes a relatively small dip in your credit score, which typically recovers within a few months, as long as you keep up with all your bill payments. (If you apply to multiple lenders for a loan of the same amount in a short period of time, credit scoring systems such as the FICO® Score* and VantageScore will treat them all as a single event, so your score will only dip once.)
Your score may dip slightly again after you've been issued your personal loan, but your score will rebound quickly as long as you keep up with your payments. If you don't keep up with your personal loan payments, your credit score will suffer a much deeper decline, as missed and late payments are the single biggest factor affecting your credit scores.
If a personal loan sounds like something that will help you meet your financial needs, consider using Experian's CreditMatch™ tool to browse loan offers matched to your credit profile. Whether you'll use the funds to get through a time of stress or to pay for a joyous occasion, a personal loan can be a great tool for managing expenses.