It's the fastest-growing debt category in the country, but if you are thinking student loans or credit cards, you're wrong.
Personal loan balances now exceed $300 billion, as of the second quarter of this year, according to Experian, a whopping 11% yearly increase. For good reason, too, as personal loans can help to consolidate credit card debt, or make funds available for major projects, such as a home remodeling effort. For many of us, the allure is hard to ignore, but personal loans do differ in some key ways from other types of credit you might use, such as credit cards. It's important to understand the key differences before signing on the dotted line.
Interest rates vary dramatically
As compared to credit cards, personal loan interest rates can vary much more dramatically, according to research by ValuePenguin. In fact, some borrowers with excellent credit may qualify for loans with interest rates as low as 5% or 6% with some lenders. On the other hand, borrowers with poor credit may encounter rates higher than the average credit card, sometimes exceeding 30%.
This wide range of interest rates make personal loans more affordable for those with better credit, and may make the most sense for borrowers with excellent credit who can pay off the loan in a timely manner. On the other hand, borrowers with poor or fair credit may face interest rates higher than what they'd otherwise qualify for with a credit card.
Borrowers with less-than-stellar credit should keep in mind that if your overall finances aren't in great shape, turning to a personal loan for more cash is not likely to help if it means higher interest rates and monthly payments. Consolidating payments using a personal loan wouldn't make sense in this scenario. Consider credit counseling options, or try to negotiate a lower interest rate with your credit card servicer.
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Shorter repayment schedule and origination fees
Most personal loans are serviced on a three-to-five year repayment schedule, which means your minimum monthly payment will be higher than with a credit card. (Of course, paying the minimums on a card is never a good idea, but the option does exist for those times when other financial needs arise.)
Also, personal loans often also charge origination fees which can add to your repayment burden, and may reduce the total amount of cash at your disposal from the loan. Plus, to qualify for some loans if you don't have great credit, you'll likely need collateral for a secured loan. That means you put your collateral in peril if you can't make the payments.
Perks and benefits
Unlike credit cards, personal loans less frequently offer perks or rewards, such as cash back, points, or airline miles. If you're spending consistently on your credit cards, you'll forego those rewards by consolidating the debt onto a personal loan. And chances are that if you qualify for a consolidated personal loan with rates lower than your credit card, your credit is likely good to begin with.
The bottom line: For borrowers with good to excellent credit, personal loans can add to your credit mix, and reduce the interest you pay for large home-improvement projects or other major expenses. For those with less-than-perfect credit, however, consider whether factors like interest rates, origination fees, and lack of perks, and whether a personal loan will result in significant savings.
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