The Pros And Cons Of a Personal Loan


Should I apply for a personal loan?

If you’re wondering whether it’s the right thing to do,  you’ve come to the right place.

There are many reasons why you might want to take out a personal loan.  Perhaps you’d like to get your hands on those new set of wheels or maybe you’re expecting your first baby. Whatever the reason, a personal loan can be the most efficient means to make your dreams come true faster.

Let us walk you through the nitty-gritty of getting one of these loans.

What Is a Personal loan?

A personal loan is a fixed-rate installment loan, normally ranging from $500 to $100,000 and they are usually unsecured, so there is no collateral that covers them.

The loan always has a fixed monthly payment amount and an end date when the loan would be fully paid off.  Interest rates will differ from lender to lender and your creditworthiness.

Borrowers commonly use a personal loan to consolidate credit card debt or pay for a big, one-time expense like a surgery, wedding or a funeral.

How Do They Work?

If we were in the 80’s and you were applying for a loan, lenders would first want to know your credit score and you must show them your tax returns and employment details.  Only then would they decide whether to give you a personal loan or not and if so, how much interest to charge you.

But now, in our technology-driven time, a whole new type of lenders has emerged.  These lenders utilize non-traditional factors such as your SAT scores and social media accounts to make decisions on your loan application.  Comparatively, it’s a lot easier to get a personal loan now than it was years ago when the only options were credit unions and traditional banks.

Personal loans come in many sizes and lengths.  You have loan terms that can go for a full year or more.  You have short loans such as payday loans that become due in just a couple of weeks after they lend you the money.

The usual practice is, if you are able to repay a payday loan within the small window of time they give, you won’t have to pay interest at all.  However, the lender will still require you to pay the origination fee for the loan.

Some other forms of personal loans start accumulating interest right at the start such as installment loans.  The amount of interest you have to pay will depend on how much your loan is and the interest rate you agreed to pay.  Some lenders adjust the interest rate downward if you get a loan with a longer term.

Let’s go through the pros and cons of a personal loan.

The Pros And Cons Of a Personal Loan

Personal Loans Advantages

Unsecured Loans

We’ve mentioned before that personal loans are unsecured loans.  This means that the lenders will not require a mortgage of assets or a guarantee for them.  This is where personal loans have an edge over other types of loans because even if you don’t have any fixed assets to offer, you can still get a personal loan to get you out of a bind, or even for other purposes such as investment.

In effect, you do not have to worry about losing your home or any of your other assets in case you encounter a financial setback and fail to make on-time payments.

Easy Application Process

These loans are available in almost all banks or financial institutions.  They need minimal paperwork and the time they need to verify the documents make the process of application quick, easy and simple.

The whole loaning process – from application to documentation and then release – takes less time compared to other kinds of loans.

So, when the need for funds is quite urgent, a personal loan is probably the best option.

Available For Any Purpose

Lenders will not obligate their borrowers to specify the purpose or reason for applying for a personal loan.  Unlike housing loans where they restrict the use of the funds only for construction or purchase of a house, or an auto loan that you can only use for purchasing a vehicle, personal loans are multi-purpose.

Fixed Terms

With a personal loan, you’ll pay a specific amount of interest for a specified number of years.

Consider it this way:  shorter terms means lower interest over the years but higher monthly payments.  So, while it is an advantage, it could also be a disadvantage depending on where you sit.

Single Payment Option

Here’s how it goes:  by consolidating multiple credit cards with a personal loan you will only have to keep track on one bill due instead of many.  It would dramatically simplify a lot of things.

You can then focus your time, attention and resources on making that single payment, ticking off the months until you completely wipe out your debts.

Personal Loans Disadvantages

Higher Rates and Payments

Since unsecured personal loans are riskier than those secured by property, lenders mitigate the risk by charging higher interest rates.  Take note that your rate will depend greatly on your credit score and the principal of your loan.  The secret is this:  some lenders may hide a significant portion of the interest in upfront fees such as loan origination and processing fees.

It keeps you in debt (and it’s getting bigger). Many banks and financial institutions will not allow partial repayment of a loan. Needless to say, this will result in your debt getting bigger and bigger due to the accrued interest.

So, if you take out a personal loan for $10,000 and want to repay $1,000, you won’t be able to.  The lender will not allow such partial payment unlike in the case of housing and other types of loans.  With other loans, you can reduce the amount of your loan through the repayment feature which also lowers overall interest.

Stiff Repayment Rules

Yes, you can choose your repayment period but first a warning: you can’t change it once it’s chosen.  Most lenders do not want to go through the hassle of modifying your terms.  This means that you can not prepay the loan or make part-payment.

Basically, you have to pay the required amount for the entire duration.  Plus, if you fail to pay the EMIs on time, you may already be courting legal action which could lead to more complications.

Strict Eligibility Criteria

Lenders obviously need to follow strict guidelines with respect to eligibility criteria for personal loans.  Most banks and NBFCs will insist that borrowers meet a certain income level before even considering applying for a loan.

Aside from the income, they will scrutinize the credit score of an applicant and you’d be right to think that they can reject a loan due to a poor or average credit score.

The Bottom Line

To sum up, a personal loan is ideal when there is a short-term cash requirement but the borrower does not have any available collateral and needs the money fast.  However, before taking this loan, a borrower should remember that this loan carries a higher interest rate.  Financially, it can lead to more problems if he is not able to pay the loan.