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Is Taking Out a Personal Loan Bad?

Are Personal Loans Bad? When Not to Apply
Susan Guillory
Susan GuilloryUpdated November 10, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
If you’re in need of extra cash, whether that’s to renovate an old bathroom, pay off credit card debt, or even take a vacation, a personal loan may be the solution you’re looking for.However, you’ve heard mixed things about personal loans. Are personal loans bad? Will they make your financial situation worse or damage your credit?A personal loan is a big responsibility. Used smartly, it can be a wonderful tool. Used irresponsibly, it could damage your credit long-term. 

What Personal Loans Are and How They Work

A personal loan is a lump sum of money given to you by a bank, credit union, or online lender. Personal loan amounts typically range from $1,000 to $100,000 and come with fixed interest rates. Loan terms are typically two to seven years, but may be shorter or longer depending on the lender. To pay off the loan, you make fixed monthly payments to the lender, including interest and fees.Personal loans are typically not backed by collateral and you can use a personal loan for just about any purpose. Since they aren’t secured with collateral, interest rates may be higher than you’d otherwise see on a secured loan, such as a mortgage or an auto loan.As far as how a personal loan works, you would apply for one at your local bank, credit union, or with an online lender. Depending on your personal financial profile, you’ll either be approved or denied the loan. The lender is going to look at your credit score, debt-to-income ratio, proof of income and employment, and more.

Are Personal Loans Bad?

Personal loans are not necessarily bad, and can actually help boost your credit score with regular, on-time payments. However, because interest rates and fees may be high, a personal loan should only be used when absolutely necessary, such as for an emergency expense, or if it will allow you to save money, such as by consolidating debts with higher interest rates.While it may be tempting to take out a personal loan to use on a vacation or go on a shopping spree, this is not recommended. You’ll end up paying significantly more for your purchases due to interest on the loan.Recommended: How to Save Money for a Vacation

3 Instances When Personal Loans Can Be a Good Idea 

In the right situation, especially if personal loans interest rates are low, taking out a personal loan might be wise. Here are three instances when a personal loan may be a good idea:

1. Home Improvement

Taking out a personal loan to fix or update an area of your home could be beneficial. Why? Taking out home improvement loans allows you to not only renovate your home to be more enjoyable and beautiful, but also can increase the value of your home. An investment now might help you sell the home for more later.Recommended: 6 Bathroom Remodel Financing Options

2. Debt Consolidation 

If you have multiple forms of high interest rate debt and are looking to pay them off faster, a personal loan for debt consolidation may be beneficial, especially if the interest rate on the personal loan is lower than on your current debts.With a debt consolidation loan, you roll all those payments into one loan with one interest rate and one monthly payment. In the long run, you may save in interest and be able to pay down or pay off your debt faster.

3. Emergencies 

If you had an emergency that cost several thousand dollars, do you have the money to cover that expense in your bank account right now? If you don’t, you’re not alone. Around half of Americans have less than three months’ worth of emergency savings set aside.A personal loan can be used to pay for emergency expenses. Simply take out the amount you need to cover the emergency and pay it back monthly over the course of the loan term.Recommended: 10 Benefits of Personal Loans

When Are Personal Loans a Bad Idea?

While personal loans aren’t necessarily bad, there are certain situations in which they should be avoided. In these examples, a loan may do more harm than good.

Discretionary Spending 

Borrowing money for discretionary spending — that is, unnecessary things like spa services and unneeded clothing — can be a recipe for disaster. You may have a closet full of designer clothing, but you also now have a monthly loan bill to cover. If you can’t afford to pay it, you run the risk of defaulting on the loan, which will then cause your credit score to plummet.

Problems Managing Debt 

Maybe you took out a loan and you’re having trouble paying it, so you think taking another loan out to pay the first is a wise idea.Not so, because now you have two loans to juggle.Now, this is a different situation than what we discussed above with debt consolidation loans. If you’re already paying loan debt, it may be wise to consolidate it. But, if you’re looking to cover existing debt, a second loan won’t ultimately solve that problem. Instead, consider asking your lender to refinance the loan so you have lower monthly payments.

No Credit Check Loans 

If you don’t have great credit, you might have assumed you’d never qualify for any kind of personal loan. But then you find an offer for a no credit check loan. The lender won’t even look at your credit score, and will possibly lend you thousands.While this may be tempting, these loans typically come with exorbitant interest rates. You’ll end up paying far more to borrow money with a no credit check lender than any other, and that could make your credit situation even worse.

You Have Access to Cheaper Credit 

There are less expensive ways of borrowing money than taking out a personal loan. These include home equity loans, 0% interest credit cards, or borrowing from family or friends. If you’re able to access a cheaper form of credit, it makes sense to go that route than it does to take out a personal loan.

Paying for Basic Expenses 

If you’ve been struggling financially and can’t quite make ends meet, you may decide to borrow money to help pay your bills.However, if you can’t afford to pay your bills, you’ll more than likely struggle to make an additional loan payment each month. You may be better off tightening your belt for a while until things get better.

Borrowing to Invest 

Investing is never guaranteed. It’s risky, and markets are volatile. You might take out a personal loan for $10,000, fully expecting to make $20,000 on the deal, but what happens if you don’t? How will you repay the loan? Trying to make money on this investment could put you in financial distress.Also, many lenders do not allow using a personal loan to invest. If you do plan on using one for that purpose, make sure to choose a lender that does not prohibit it.

Weighing the Pros and Cons 

There are many pros and cons to taking out a personal loan. Consider both before deciding if taking out a personal loan is right for you.
Provide capital for projects or emergenciesYou must be able to afford to pay it back
Paying a loan on time can build your credit scoreMissing payments can make your credit score drop

Is Taking Out a Personal Loan Right for You?

Deciding whether or not to take out a personal loan is something only you can answer for yourself. If you plan on using the personal loan for an emergency or necessary expense, it may be worth it. However, if you plan on using it for a vacation, you may want to weigh the pros and cons to determine if this is a good financial move in the long run.You also can shop around for personal loans at your bank and with online lenders. If you’re able to get a good interest rate with a monthly payment you can afford, taking out a personal loan may be right for you.Recommended: Types of Personal Loans

Alternatives to Personal Loans

If you decide you do not want a personal loan or if you’re struggling to qualify, there are other financing options you can consider. These include:

Home Equity Loans

A home equity loan uses your home as collateral to fund the loan. Because of this, interest rates are typically lower than with personal loans. However, if you default on a home equity loan, you risk losing your house. Make sure you can afford the monthly payment before committing to this option.

Family or Friends

While not ideal, a family member or friend may be able to help get you out of a pinch. The beauty of borrowing from someone you know is they most likely will not charge you interest. Make a plan regarding how you’ll pay them back, and stick to it. If you’re unable to pay them back in a timely manner, it could harm the relationship.

Credit Cards

Credit cards only charge you interest on the amount you use, and that’s only if you don’t pay it off in full at the end of the cycle (or month). If you need a smaller amount of money to tide you over until your next paycheck, for example, a credit card may be a better solution than a personal loan. However, interest on credit cards is typically higher; so if you don’t think you can pay it off in full, a personal loan may be a better fit.

The Takeaway 

It is not bad to take out a personal loan, assuming you truly need the money and have a plan to pay it back. For the right purposes (loan reconsolidation, home remodels, emergencies), having cash on hand can help you now and in the future.Lantern by SoFi can help you find financing that’s right for you. With a single application, you can explore different lenders, interest rates, and loan amounts, all with no obligation to you.

Frequently Asked Questions

Does taking out a personal loan look bad?
What is a disadvantage of getting a personal loan?
Is a personal loan a good or bad debt?
Photo credit: iStock/Dmitry Kopylets

About the Author

Susan Guillory

Susan Guillory

Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.
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