Personal Loan Pros and Cons: What’s Worth Knowing Before You Apply
As of the third quarter of 2020, 43 million personal loan accounts were active in the United States. These accounts, in turn, held an average balance of $16,458, an increase of $199 from the previous year.
Those figures highlight how personal loan usage has increased considerably over the years. So much so that 22% of US adults carry such a loan.
As accessible as these financial products are, though, they do come with certain risks. As such, it’s imperative to learn more about personal loan pros and cons before you apply for one.
This guide will give you an insider look at personal loans and their upsides and downsides, so be sure to read on.
Importance of Knowing the Pros and Cons of Personal Loans
It’s vital to know the pros and cons of getting a personal loan as it can impact your creditworthiness. Your creditworthiness, in turn, refers to how trustworthy you are in the eyes of lenders. So, the more creditworthy you are, the more willing a lender is to trust you to repay your debts.
For example, a lender may judge you creditworthy if you always pay your loans on time. You may also be creditworthy if you limit your credit utilization to only 30% or lower.
By contrast, you may become the opposite of creditworthy if you fail to repay a personal loan on time. The same is true if you take out a personal loan amount too big for your income.
The Upsides of Taking Out a Personal Loan
As the folks at Plenti put it, there’s a loan for “almost” anything you need financial help for. You can get a personal loan for a vacation, a wedding, a home renovation, or even to install solar panels at home.
What’s more, most lenders don’t require you to provide a specific reason for taking out a personal loan. So long as you meet their requirements, they’re likely to fund your needs, whatever those needs are.
Aside from not requiring a reason for the loan, here are some other benefits of personal loans.
May Help Improve or Build Your Credit Score
In the US, the payment history makes up 35% of a consumer’s overall credit score. That makes debt repayment the biggest variable that can affect your credit score. On the other hand, your credit utilization ratio (CUR), while also hefty, only makes up 30% of your total score.
Because of its huge impact, having a perfect payment history can help you boost your credit score. So, if you take out a personal loan and make certain to pay it on time, then doing so can raise your score. For the same reason, making timely personal loan repayments can help you build a credit score.
From there, the better you can make your credit score, the better your odds of securing future credit.
Accessibility and Ease of Application
Banks and credit unions are no longer your only lender options for personal loans. Today, you can rely on financial technology (fintech) lenders to issue you a loan, too.
In fact, a 2019 report found that fintech lenders originated 38% of personal loans in the US. That’s a staggering increase of 33% from their 5% share back in 2013.
One reason for that incredible jump is that applying for a fintech personal loan is 100% online. Even the approval and fund disbursement processes all occur over the Internet. This means that as soon as you get approved, you can expect the lender to send you the approved funds digitally.
In addition, many fintech lenders have borrowing requirements laxer than that of banks. For example, they won’t reject your application right away, even if you only have a fair credit score. Instead, they may still qualify you, albeit for a lower amount or a higher interest rate.
Fast Approval and Availability of Same-Day Funding
With the rise in fintech lending, banks have also simplified their lending game. For example, it used to take them weeks to process applications, but now, it only takes several days. What’s more, banks and credit unions will let you know if you get approved or not.
If you get approved, you can expect to get the funds within the same day or the next. All in all, most traditional lenders now complete applications within a week or less.
However, if you need the funds right away, a fintech lender may be your better option. These companies usually fund approved applications the following day. Some even send the funds the same day you apply and get approved.
They Can Get You Out of a Pinch
Fast-approval and quick-funding personal loans may be useful in cases of emergencies. An example is if someone in your household falls ill and you need extra cash for medical or hospital bills. Since these expenses can’t wait, you may want to consider applying for a personal loan.
Another example is if your roof or plumbing system springs a huge leak. These issues require emergency repairs, as they can cause more damage if left unfixed. If you don’t have the funds to correct them ASAP, a personal loan can help finance the repair service.
You may also want to consider applying for a personal loan to help cover your overdue utility bills. After all, having no electricity, water, or gas can be unsafe, as this can put you at safety or health risk.
For example, if your power gets disconnected, your home may become a target of criminals. If it’s your water, then you won’t have any means for personal hygiene, which is a big no-no in today’s pandemic. If it’s your gas service, you’d have no heating at night, which can put you at risk of weather-related illnesses.
The Biggest Downsides of Personal Loans
Whenever you apply for a traditional personal loan, your credit score can decrease a bit. That’s because lenders have to carry out a hard inquiry on your credit report. They do so to gauge your creditworthiness and your reliability of paying back a loan.
A hard inquiry on your credit report alone can lead to a five-point decrease in your FICO score. That may not be significant, but keep in mind that such a deduction occurs for every hard check. So, if you apply for, say, three loans right after each other, your score can go down by as much as 15 points.
In addition to requiring hard inquiries, here are a few other drawbacks to personal loans.
Approval Isn’t Always Guaranteed
This is especially true for bank and credit union loans, as these lenders focus on credit scores. As a result, they often extend their services only to folks with good or higher credit scores. A good credit score, in turn, is between 670 and 739, while anything higher can be very good or excellent.
If your score falls below 670, traditional lenders are unlikely to approve your loan. Fintech lenders may still grant you a loan, but prepare yourself for a much higher interest rate.
High-Interest Personal Loans Can Be Very Expensive
One of the biggest cons to personal loans is that they can cost you up to thousands of dollars in interest alone. This depends on the interest rate, but the higher it is and the bigger the principal, the costlier the loan is.
For example, suppose you take out a $10,000 personal loan with a 15% interest rate. This means that for interest alone, you’d already pay $1,500. So, just the principal and interest fees would cost you a total of $11,500.
Missed Loan Payments Can Severely Hurt Your Credit Score
Most personal loans come with monthly installment payments. You need to pay back each installment in full on or before the monthly due date. Otherwise, you may wind up with a missed payment, which can stay on your credit report for up to seven years.
That means a single missed payment has the potential to hurt your credit score for over half a decade. If this happens, you may have a harder time securing new credit in the future.
Late Payments Often Have Extra Charges
Even if you don’t miss a loan payment but were still late in making it, you may have to pay an extra late fee. You need to pay each late fee on top of the amount due.
The late fee depends on one lender to another; some may charge between $25 and $50 per late payment.
Other lenders may charge a late fee on a percentage basis of your monthly amount due. For example, they may require you to pay around 3% to 5% of the amount you pay for every month. So, if your monthly amount due is $2,000, a 3% late fee may cost $60, while a 5% late fee may cost $100.
Weigh These Personal Loan Pros and Cons Before Applying for One
As you can see, there are numerous personal loan pros and cons you need to consider before getting one. However, the most important thing is to keep in mind that these loans can be helpful, provided you pay them on time. After all, it’s all the late or missed payments that can put your financial future at serious risk.
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