Despite what you might hear from certain corners of the personal finance realm, debt is not the root of all evil.
Financially responsible folks use credit cards for everyday purchases, finance car purchases with secured vehicle loans, and take out mortgage loans to purchase homes they could never dream of paying for in cash.
Secured and unsecured personal loans are increasingly popular with judicious borrowers too. According to data from Experian, U.S. personal loan balances hit $273 billion in the second quarter of 2018, up 11.4% from the second quarter of 2017. Personal loan balance growth outpaced credit card, student loan, auto loan, and mortgage balances, all of which grew by well under 10%. Fintech startups like Lending Club and SoFi, which generally have user-friendly online applications and offer rapid funding, drive much of the space’s growth.
Consumers’ affinity for personal loans isn’t surprising. Compared with alternatives like credit cards and payday loans, unsecured personal loans have several key advantages. Though less common, secured personal loans hold real value for qualified borrowers, as well.
Here’s a closer look at the key benefits of secured and unsecured personal loans and some of the main reasons you might consider using them.
Benefits of Taking Out a Personal Loan
Why should you prefer a personal loan over common alternatives? Consider these benefits, but remember that the ideal credit product for any given situation depends on numerous factors, including borrower credit, income, assets, preferred repayment term, and intended loan or credit line purpose.
1. Potential for Higher Borrowing Limits Than a Credit Card
According to the Consumer Financial Protection Bureau’s report The Consumer Credit Card Market 2017, average credit line size in 2017 ranged from a little under $10,000 for super-prime borrowers, to about $6,500 for prime borrowers, to about $1,250 for subprime borrowers.
Each card’s spending limit falls within a range defined by the issuer or card network, with lower limits reserved for applicants who barely qualify for the card and higher limits for very well-qualified applicants. For instance, credit limits on a secured credit card designed for consumers with impaired credit might range from $300 for the weakest applicants to $5,000 for the strongest. On a no-annual-fee cash back credit card, limits might range from $2,500 to $10,000. On an ultra-premium travel credit card such as Chase Sapphire Reserve, limits might range from $10,000 to $50,000.
Like personal loan providers, credit card issuers use several factors to set spending limits. Most come from consumer credit reports:
- Debt-to-income ratio
- Recent bankruptcies or delinquencies
- Timing and frequency of credit inquiries (hard credit pulls)
- Payment patterns on other active credit accounts
- Income and employment history
- Credit score
Personal loan borrowing limits tend to be more generous than credit line limits. While borrowing limits vary by lender, most personal lenders cap loan principals at $25,000 to $30,000. Some are more generous; SoFi allows qualified borrowers to apply for up to $100,000 in a single loan.
2. Potential for a Lower Interest Rate Than a Credit Card
Personal loan interest rates are typically lower than credit card interest rates for comparable borrowers.
Unsecured personal loan rates start at 5% or 6% APR for very well-qualified borrowers. By contrast, it’s rare to find even low-APR credit cards with regular APRs under 10%, regardless of applicant strength. Plenty of credit cards have low or no-interest introductory offers that last 12, 15, or even 21 months, but rates spike to 10%, 15%, 20%, or higher once the intro period ends.
3. Collateral Usually Isn’t Required
Unsecured personal loans don’t require borrowers to put up collateral. The consequences of defaulting on an unsecured loan are severe, but the loss of a vehicle, house, or priceless family heirloom isn’t among them.
4. Easier to Manage Than Multiple Credit Card Accounts
A single, fixed-rate personal loan funded in a lump sum is much easier to manage than multiple credit card accounts with different spending limits, interest rates, payment due dates, and issuer policies. If you know you need to borrow $25,000, why not apply for a single personal loan in that amount rather than four credit cards with spending limits of $6,250 apiece?
5. Predictable Repayment Schedule
Personal loans are installment loans with fixed interest rates, repayment terms, and monthly payments. At approval, you’ll learn precisely how much you’ll need to repay each month, how many monthly repayments you’ll need to make, and your total interest cost over the life of the loan.
Revolving credit lines, such as credit cards and home equity lines of credit, aren’t so predictable. The only constant is your monthly payment due date; your required minimum monthly payment depends on your credit utilization, and your interest rate is subject to change with benchmark rates.
6. Longer Repayment Term Than Some Alternatives
Most personal loans have repayment terms of two to five years, but some unsecured personal loan providers offer terms of seven years or longer. Popular subprime alternatives such as payday loans and pawn shop loans have far shorter terms — and far higher interest rates.
Top Reasons to Get a Personal Loan
These are among the most common reasons to apply for a personal loan. Be aware that your loan purpose may affect the size, rate, and repayment term of your loan. If permitted, putting up collateral to secure a loan is almost certain to reduce your interest rate.
1. To Refinance Existing Debts
Many unsecured personal loans are debt consolidation loans taken out for the express purpose of consolidating multiple existing loans or lines of credit into a single loan, often at a lower interest rate.
Debt consolidation loans:
- Are easier to manage than the multitude of credit lines they replace
- Are predictable since they’re installment loans with fixed payments
- May have lower monthly payments, particularly when they consolidate credit card debt
How Debt Consolidation Loans Work
Let’s say you have $20,000 in existing credit card debt spread across four accounts on which you’re currently making minimum payments totaling $800 per month.
You apply for a single unsecured personal loan with a $20,000 principal, or perhaps a few percentage points more if your lender charges an origination fee. You use your loan’s proceeds to pay off your four credit cards right away. Then, for the remainder of your unsecured loan’s term, you make fixed monthly repayments. When your loan is paid off, you’ll have reached the end of the debt journey that began the first month you failed to pay off one of those four credit cards in full.
What to Look for in a Debt Consolidation Loan
The ideal debt consolidation loan:
- Has a lower interest rate than the average rate on the consolidated debts
- Has a significantly lower monthly payment than the combined total of the consolidated debts (this is a function of loan rate and term; for example, the monthly payment on a $20,000 unsecured personal loan with a five-year term and 10% APR is around $425)
- Is large enough to meet your debt consolidation goals
2. To Finance a Major One-Off Purchase
An unsecured personal loan may be a suitable financing solution for a major one-off purchase if:
- Your credit, income, and other underwriting factors qualify you for an interest rate significantly lower than your most affordable regular credit card APR
- You don’t expect to be able to pay off the purchase by the end of any 0% APR promotion window (windows are usually 21 months at most, compared with 60 months or longer for a typical personal loan)
- The vendor doesn’t accept credit cards
- Your combined credit limit isn’t high enough to cover the full cost, and you don’t want to apply for another card
Common one-off purchases for which you might take out a personal loan include:
- Transportation. If you’re buying a new or used car from a dealership, you’re likely to get a lower rate and smaller monthly payment with a secured vehicle loan, but an unsecured personal loan may be your best bet in a private-party transaction that conventional lenders won’t finance directly. You can use your loan’s proceeds to fund a cash withdrawal or bank check issue.
- Home Improvement. If you lack sufficient equity in your home — at least 15%, or an 85% loan-to-value ratio — to qualify for a secured home equity loan or line of credit, an unsecured personal loan may be your next best bet to finance a home improvement project such as a kitchen renovation. You can use the loan’s proceeds to fund project-related purchases, perhaps by a debit card or rewards credit card tied to the funding account, as long as you pay any credit card balance in full each month.
- A Vacation. If you can’t pay for a major vacation in one lump sum, you can take out a loan before you reserve your airfare and hotel and use the remaining proceeds to cover expenses incurred during the trip itself, such as tours, attraction admission, restaurant meals, and souvenirs. While you shouldn’t use a personal loan to justify taking a vacation you can’t afford, it can help you spread out the expense of a vacation over several manageable monthly payments.
3. To Cover Unexpected Major Expenses
Not all big-ticket expenses are voluntary, and some can’t wait. When the unexpected happens, fast funding comes in handy. You might consider a personal loan for common unexpected expenses such as:
- Major medical bills
- Emergency vehicle repairs not covered by auto insurance (such as pricey jobs like replacing a transmission)
- Urgent home repairs (such as repairing or replacing a failing furnace during the winter)
Many online lenders fund loans the same day that you accept their loan offer, and others almost always fund within two business days. If you begin shopping for a personal loan within days of incurring the expense, your loan’s funding should come through before you incur interest charges or miss any payment due dates.
Alternatively, you can pay the initial expense with a rewards credit card — if your credit limit allows and the vendor accepts credit cards — and use your loan’s proceeds to pay off the credit card balance in full by the due date. On a $5,000 bill, 2% cash back adds up to $150.
4. To Finance a Wedding
Though a wedding is technically a one-off event, it’s a different beast than an emergency home repair or planned remodel. That’s because most weddings require many months of planning and preparation. In major metropolitan markets, catering and venue reservations need to be made a year or more in advance. Engagement jewelry may come even sooner; I bought my wife’s engagement ring 18 months before we officially tied the knot.
Were I getting married today, I’d seriously consider taking out a personal loan before making my first wedding-related purchase, setting up a separate free checking account to hold the loan’s proceeds and disburse its monthly payments, and otherwise use the account exclusively for wedding-related purchases. I’d choose a longer-term loan — 60 months, most likely — to keep repayments manageable and ensure the loan’s balance didn’t prematurely deplete.
5. To Adopt a Child
Kids are expensive in general, but adoption presents significant upfront costs, such as:
- Travel and lodging for the adoptive and birth parents
- Legal fees for the adoptive and birth parents
- Medical expenses for the adopted child
International adoptions involve additional fees, including:
- Agency fees
- Citizenship application and other administrative fees
The private adoption agency American Adoptions reports that the average cost to adopt in the early 2010s approached $40,000. Depending on the origin country, international adoptions were even pricier — nearly $46,000 for children adopted from Ethiopia in 2012 and 2013, for example.
Like wedding planning, the adoption process can drag on for years. And federal tax credits for adoptive parents often fail to cover the burden; in 2018, the IRS capped the adoption tax credit at $13,810 per child. If you determine that the cost of your adoption will outstrip the maximum federal tax credit, consider using a personal loan to borrow the difference between your estimated final cost and the maximum credit.
6. To Make Tax Payments
Your quarterly estimated tax payments are zero-interest, short-term loans to state and federal revenue authorities. Why should you pay interest on the funds with which you make those advances?
For starters, because your cash flow demands it. If you operate a business or sole proprietorship that earns irregular or seasonal income — such as a restaurant in a seaside vacation town or an accounting firm that specializes in tax preparation — you might not have sufficient funds on hand to make equal-sized payments in April, June, September, and January.
If you expect to be able to pay your balances in full by the statement due date or soon after, one option is to pay your taxes with a credit card. Without the extended grace of a multi-month 0% APR promotional period, though, high interest costs weaken the case for credit card tax payments over longer terms. A lower-interest personal loan is a more cost-effective alternative.
7. To Start or Expand a Business
If you need money to start a business or jumpstart your career as a solopreneur, you don’t have to apply for a commercial loan. An unsecured personal loan will do just fine, provided its principal is sufficient to cover your initial startup costs.
Best Personal Loan Companies
Before you take out a personal loan, it’s important to do your due diligence. Look into the terms each company offers and figure out what will be best for your needs. Here are a few of the best personal loan lenders available.
Unlike many personal loan companies, SoFi doesn’t charge origination fees or prepayment penalties. Plus, they’re one of the only companies to offer loans of up to $100,000. With terms of two to seven years, you can choose the repayment option that fits your needs. And if you lose your job, you may qualify for unemployment protection, allowing you to pause your payments temporarily.
Upstart believes there’s more to a person than their credit score. That’s why they also consider education, income potential, and work history when making lending decisions. You have the option to choose either a three- or five-year repayment plan, and there are no prepayment penalties.
Lending Club gives you the ability to apply for a personal loan and receive a decision within minutes. Through this peer-to-peer lending platform, you’ll make one fixed monthly payment, which is great for anyone looking to consolidate high-interest debt. Lending Club does not charge a prepayment penalty, but they do have an origination fee of 1% to 6%.
While the above are among the most common justifications for taking on new debt in the form of a personal loan, they’re not the only reasons to do so.
Indeed, if you’ve applied for a personal loan online recently, you’ve surely noticed the choice of “Other” in the “Loan Purpose” dropdown menu. Personal lenders are just as anxious to underwrite your loan as you are to get it funded, to the point that they’re willing to consider loans that fail to fit common use cases.
That’s great news for borrowers. As long as you meet basic credit and income qualifications, and you’re perhaps willing to accept a smaller loan than you’d like, the chances are good that you’ll find a lender willing to approve your application. Time to start thinking about how you’ll use your loan’s proceeds.
Have you ever applied for a personal loan? What was your reason?