When Is Taking Out A Personal Loan A Good Idea?

A personal loan is a loan you can use to fund any purpose. But before you start scheming about what you’d do with an extra few grand, it’s important to understand how this type of loan works so you can determine if taking on this debt is right for your situation.

Common Reasons to Get a Personal Loan

While you could take out a personal loan to update your wardrobe or hit the slopes in Aspen, that’s not what most people do with the money.

Typically, funds from a personal loan go towards:

• Paying off or consolidating higher interest debt (usually from credit cards)
• Covering the cost of home improvements or repairs
• Responding to an urgent, unplanned for expense
• Flesh out a business idea

Terms of a Personal Loan

Now that we’ve looked at the primary uses of a personal loan let’s review the mechanics of how they work.

Secured vs. Unsecured

A personal loan can be either secured or unsecured, with most being the latter. That means your creditworthiness and income are typically the sole determinants of your getting loan approval.

However, if you don’t qualify for an unsecured loan, or you’d like more favorable loan terms, you could ask the lender to make it a secured loan.

When taking out a secured personal loan, the lender will generally use your other accounts held at the institution as collateral in case you default.

Revolving vs. Installment

A personal loan is an installment loan. Which means you’ll make a payment each month until you pay off the obligation.

Depending on the terms, personal loan repayment periods typically span 2–7 years. Once you repay the note, the lender will close the account. If you need to borrow more, you’ll have to apply for another loan.

Interest Rate

Interest rates on personal loans vary dramatically and can range from 5–36%, based on your creditworthiness and lender.