A personal loan can be a valuable option when you need quick cash. However, there are a lot of pros and cons that come with it. You should be well aware of what a personal loan entails before you sign on the dotted line. To make sure that taking out a personal loan is the right decision for you, review the following primer detailing the various aspects that constitute this loan type.
No Collateral Equals Higher Interest Rate
Unlike a mortgage, which uses the house as collateral, a personal loan does not have anything for the bank to seize if you do not pay. This is called an unsecured loan, in comparison to a secured loan, because it is solely based on your creditworthiness without any sort of collateral. For this reason, the banks offer a higher interest rate because it is a riskier deal for them. And if you have a poor credit score, this means that the interest rate will be significantly higher.
Interest Rate and APR May Not Be the Same
According to the article “5 Things You Need to Know Before Taking Out A Personal Loan,” the interest rate and the APR, annual percentage rate, may not be the same. Perhaps the bank gives you a 9% interest rate but then charges a 4% origination fee, which would result in a rate of 13%. Make sure you understand exactly what you are getting with your loan starting with the APR.
Reasons for Taking Out A Personal Loan
A personal loan can be a lifesaver when you need money to cover an unexpected expense. However, due to the higher interest rate, it may not be the best option. It is definitely not a good idea to use it to pay for a vacation or gambling but should only be considered for emergency situations. These may include a sudden repair that you need to make on your home or medical bills.
Another reason why a personal loan may be used is to consolidate debt. Rather than paying for several different lines of credit with different interest rates, you can consolidate your debt into one loan with an interest rate that could be lower. This can cut down on the stress of paying multiple bills since you will only have to worry about making one payment instead of several. Before you transfer your loans to another loan, make sure you are aware of what you may be giving up, such as certain federal benefits like the income-driven repayment plan for students.
Establish A Payment Plan
Before taking out a personal loan, you should review your budget first. See how this new payment will work itself into your expenses and if you are able to handle it. Determine where you can tighten your belt in other areas to give yourself a cushion and to make sure you aren’t straining your income to the point where you can’t meet your current saving plans.