5 Reasons for Personal Loans: Are They Right for You?
Personal loans are popular, but you may want to consider all options before committing to one.
Contributing Writer at Tally
September 15, 2022
When it comes to lending options, you may be familiar with things like credit cards, mortgages and auto loans. Another option that’s grown in popularity over the past few years is the personal loan. The reasons for personal loans are varied, as they can be used for many different things — unlike a mortgage, which you can only use for the purchase of a home.
We’ll go over what personal loans are, then we’ll jump into scenarios in which they are most commonly used and discuss whether a personal loan is the best lending option.
Personal loans: The basics
A personal loan, according to Experian, “is a form of credit that can help you make a big purchase or consolidate high-interest debts.”
What sets a personal loan apart from other lending options is that there are minimal stipulations attached. Borrowers can use the personal loan funds however they wish. Once approved for the loan, they’ll receive the funds upfront, often in a lump-sum payout.
Repayment is required and borrowers need to make minimum monthly payments to their lender. The monthly payment will be based on the loan term; both principal and interest factor into this amount.
As mentioned previously, personal loans differ from other types of loans because of what they can be used for. Mortgages, for instance, can only be used to purchase a home. Car loans can only be used to purchase a vehicle. But personal loans can be used for an array of different things. Let’s explore five common reasons for personal loans.
The 5 common reasons for personal loans
There are many reasons for personal loans, and yours is likely dependent upon your finances. Having said that, below are five common reasons for personal loans.
1. Medical bills
Forty-one percent of American adults have health care debt, according to a recent study by the Kaiser Family Foundation. Though the three major credit bureaus recently announced changes to how medical debt impacts credit scores, those changes only affect you if you have minimal debt or if you completely pay off your debt.
If you have a large amount of outstanding medical debt, you may be tempted to pay it off, close out the bill, and stop receiving harassing calls from debt collectors. This could be particularly useful if you’re looking to clear the medical debt from your credit report in anticipation of another major purchase, like a home.
However, it’s worth mentioning that medical debt often doesn’t charge interest. Personal loans, on the other hand, do. So while a personal loan may allow you to clear your medical debt, it might end up costing you more in the long run since you’ll have to repay the loan amount plus interest.
2. Large purchases
Many people also use personal loans for large purchases, such as a vacation or wedding. Doing so allows them to finance the purchase and pay it off over time. While you could put the purchase on a credit card, personal loans may have lower interest rates than credit cards, which makes them a more appealing option.
Personal loans may be an attractive short-term solution here. However, the better alternative is to create a budget and prepare for the purchase in advance. You can put a little bit of money into a savings account each month in anticipation of your upcoming purchase. Otherwise, you’ll end up paying extra money in interest.
3. Home improvement projects
If you’re looking to remodel your home, personal loans may be an option. However, similar to the above situation, consider preparing for this purchase in advance rather than financing it. For instance, a cosmetic bathroom update could wait a few months until you’ve saved enough money to pay for the purchase in cash.
Should the home remodeling project be a bit more of an emergency, you may want to consider other financing options, like a home equity loan or a home equity line of credit (HELOC). These secured loans and lines of credit allow you to use the equity you’ve already paid into your home as collateral. As a result, you may receive a lower interest rate than if you applied for a personal loan.
4. Emergency expenses
Unexpected expenses can arise at any time. Your car may break down. Your pet may have a medical emergency. You may be forced to travel somewhere unexpectedly, perhaps for a funeral. In these circumstances, securing a personal loan may seem like a last resort, allowing you access to funds that you otherwise wouldn’t have.
Since emergencies can arise at any time, consider starting an emergency fund. Emergency funds are set aside in a separate account that’s dedicated specifically to unexpected expenses. Having this money in reserve can provide peace of mind and save you from incurring interest charges; you won’t have to take out as large of a loan — if you even need to take out a loan at all — to cover the expense.
5. Debt consolidation
Some consumers use personal loans as a form of debt consolidation. Let’s say, for instance, that you have $5,000 in outstanding balances on your credit card. Credit cards typically have high interest rates. In this case, yours is 27%.
You receive a personal loan offer with a 15% interest rate. You use the funds from the personal loan to pay off your existing card balances and then make payments on the personal loan.
This concept may sound good in theory, but there are a few issues with it. For one, the best personal loan interest rates are reserved for those with excellent credit. If you have poor credit, you likely won’t receive the lowest interest rate.
Additionally, many loan lenders charge origination fees — fixed costs required to open the loan. They can range anywhere between 1% and 5% but may even reach as high as 10%. This means if your loan is for $5,000, origination fees could cost you between $50 and $500.
Lastly, many personal loan lenders will charge prepayment penalties. While you can pay off your credit card debt entirely without penalty, paying off your personal loan early may result in a penalty from your lender. Essentially, this means that you’re locking yourself into fixed interest payments, which could potentially cost you money in the long run.
Choose the lending option that best fits your financial situation
There are many different options available when it comes to borrowing money. Personal loans are attractive because lenders often allow you to use the loan for practically anything without many restrictions.
It’s important that you have a good handle on your personal finances and know what you are getting into before taking out a personal loan. If you miss a monthly payment, your lender may charge late fees and penalties. Make sure that you can adhere to the repayment terms before accepting your loan offer. The loan will also affect your credit score.
The reasons for personal loans listed in this article are some of the most common and include medical bills, large purchases, home repairs, emergency expenses and debt consolidation.
However, there may be other lending options available for these situations, especially when it comes to debt payoff. If you’re looking for a way to pay down your high-interest credit card debt, check out Tally.† Tally is a credit card payoff app that offers a lower-interest line of credit to help you pay down debt quickly and efficiently.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.