Personal loans can be a good option for consolidating high-interest debt if you’re trying to become debt-free or need to finance a sizeable expense. However, not all loans are created equal.
In this article, we’ll discuss factors you should consider and questions you should ask yourself to decide whether a personal loan is right for you.
Types of personal loans
There are two types of personal loans: unsecured and secured. Unsecured loans aren’t backed by any collateral (such as a car or house) while secured loans are. Secured loans often have lower interest rates than unsecured loans since the lender can take the property if you default and as a result aren’t assuming as much risk.
What you should consider when evaluating a personal loan
Your loan’s term is the amount of time you have to repay it. The shorter the repayment period, the larger your monthly bills. However, short repayment periods also allow you to pay your debt off faster and typically pay less interest overall.
Your interest rate is the amount of interest you’ll pay your lender (expressed as a percentage of the principal) for the ability to borrow money. The interest rate figure does not factor in any loan fees.
APR is the amount you pay yearly to borrow money, including the loan fees. APR is a better barometer of how much you’ll spend to repay a loan than the interest rate since it’s accounting for the total cost.
Possible fees you may need to pay include prepayment, application, and origination fees. These can really add on to the total cost of the loan, so make sure you understand them before you sign on the dotted line.
Type of interest rate
Fixed interest rates, which remain the same each month, can be more expensive than variable interest rates, which can fluctuate. However, the fixed amount remains the same month over month so you’ll be able to budget without any surprises.
4 questions to ask yourself about personal loans
Here are 4 questions to ask yourself to help decide if a personal loan offer is a good fit:
1. Can you make the monthly payment?
Be honest with yourself: Can you make the monthly payment without overextending yourself financially? If the answer is no, the loan probably isn’t a good fit for you. If you default on your payments, you could wind up spiraling into debt.
2. Is the loan amount enough to cover your needs?
If your loan isn’t enough for the reason you took out the loan in the first place, then it’s essentially pointless. However, if you take out more money than you need, you could be stuck paying it back for a while with interest.
3. Which is better: lower monthly payments or less money overall?
As we mentioned earlier, shorter loan terms generally equate to higher monthly payments. Longer loan terms typically mean lower monthly payments but more cash due because of interest. Decide which is a better fit for your financial needs: lower payments over a longer period or higher payments with a sooner debt-free date?
4. How quickly do you need the money?
Knowing how long it will take to apply and the amount of time you need to wait before you receive your cash may rule out some loans.
A personal loan can help you secure the funds you need but it’s important to find a loan that works for your unique financial needs. Make sure to do some due diligence before taking out a loan—a little legwork now can save you a lot of aggravation later.
By Stefanie Gordon
Stefanie Gordon is a content strategist with over a decade of professional writing experience. She is a former financial journalist who has spent the last several years working in digital marketing. She specializes in content strategy and creation for large and small businesses in finance and technology.