The pros and cons of personal loans

When you are looking for financing, it’s important to consider all your options—including the types of lenders and their products to avoid settling for a loan that doesn't offer the best terms for you.

Personal loans are a popular choice.

As of 2023, the combined tally for personal loans alone hovered at $232 billion across nearly 23 million American borrowers. That is almost double 2017’s level of $117 billion.

Depending on the reason you are seeking credit, a personal loan may or may not be the best fit for you. Following is a deep dive into the pros and cons of personal loans to help you better navigate the many choices available.

Personal loan mechanics

As a type of financing, a personal loan can put money in your bank account quickly.

Typically, a personal loan is unsecured financing, meaning that no collateral is required. In some instances, however, a lender may require some form of collateral, such as real estate or a car.

Personal loan amounts fall within a wide range, between $100 and $100,000, depending on the borrower’s credit, the purpose of the loan, and the lender.

There is a variety of types of lenders that offer personal loans, including traditional banks, credit unions, and online lenders.

And personal loans can be used for a wide range of purposes, including debt consolidation, home repairs, medical bills, or emergencies, to name just a few.

Although a personal loan can help get you out of a pinch, they’re not ideal for every situation.

Overview: Pros and cons of personal loans

Personal loan pros

Credit building

Borrowers who have not yet established much of a credit history can find it difficult to win over lenders. And consumers whose credit profiles have been damaged are likely to face similar challenges.

In our review of the pros and cons of personal loans, credit building is a potential positive that can work in a borrower’s favor.

But keep in mind that lenders typically report payment details to the trio of major credit bureaus—Equifax, Experian, and TransUnion. This means if a borrower wants to use a personal loan as a tool to build credit, they must consistently make at least the minimum payment due, on time, every month.

Considering that payments comprise more than one-third of a consumer’s credit score, they are very important. Timely payments have a positive effect on a person’s credit score, so clearly that's a pro.

On the flip side, there's a potential con: delayed payments or delinquent accounts on a personal loan can damage a person’s credit profile and interfere with their ability to access credit in the future.

Debt consolidation

Racking up credit card debt is easy to do. With numerous accounts, chances are some interest rates are higher than others, and it can be difficult to keep track of so many bills.

Debt consolidation, therefore, makes its way onto the list of personal loans pros and cons, as a pro.

Lenders that issue personal loans for debt consolidation do so in a couple of different ways. One way is to directly pay off the borrower's credit balances from the loan proceeds, leaving the borrower with just the one new personal loan.

Or, they might simply deliver the funds directly to the borrower to pay off those accounts themselves. In either case, the personal loan leaves the borrower with a single balance instead of many to pay toward each month.

Ideally, a personal loan for debt consolidation carries a lower interest rate than the rates on the accounts being paid off. Usually, the stronger the borrower's credit score, the better the rate they can get.

Getting a personal loan for debt consolidation has numerous benefits, not the least of which is fewer bills to remember and pay each month, reducing the chances of missing a payment and being charged late fees.

Use case flexibility

Also making its way onto the list of positives when considering personal loan advantages and disadvantages is the many ways the proceeds can be used.

While some loans are meant for specific purposes, such as a mortgage or auto financing, personal loans can be used for just about anything—a wedding, a kitchen remodel, or even a vacation.

Personal loans cons

Potentially high APRs

While personal loans can sometimes be the solution to high interest rates, this is not always the case.

Depending on a borrower’s credit score, personal loans can sometimes come with above-average annual percentage rates (APRs). This is one potential con of a personal loan.

As of 2023, the average personal loan APR hovered at 11.44%. Borrowers may find they can obtain lower APRs with other loans, including home equity lines of credit, certain credit cards, and even some student loans.

Excessive debt

Considering that personal loans cater to borrowers of all income levels, it's possible for borrowers to get in over their heads. For this reason, the potential for excessive debt is another of the disadvantages of personal loans.

Because lenders generally don’t have too many restrictions on how the funds can be used, consumers have more opportunities to borrow money. As a result, borrowers have a higher chance of increasing their debt load, potentially beyond what they can reasonably afford.

Risky collateral

It’s true that most personal loans are unsecured and therefore don't require collateral. But it's also possible for a borrower to use some asset they own, such as property or a car, to back the loan. This feature could make it onto both sides of the pros and cons list of personal loans.

Here, having to put up collateral will be considered one of the disadvantages of personal loans because having to use collateral usually means a borrower can’t otherwise qualify for a loan—usually due to a low credit score.

Sometimes, the reason for a poor credit score is a history of missed payments. In the case of a secured loan, if that pattern of missing payments continues, the lender can take possession of the asset used as collateral.

So the borrower runs the risk not only of defaulting on the loan and damaging their credit, but also losing the asset they’ve put up to secure the loan.