When Are Personal Loans a Good Idea: A personal loan can be used for most purposes, including debt consolidation, home improvement projects, and medical bills. Interest rates are typically far cheaper than credit card APRs, making them an attractive option, especially for borrowers without collateral.
However, personal loans are usually more expensive than other options, such as home equity loans, especially if you have less-than-stellar credit. Here’s how to decide if a personal loan is right for you.
Key Takeaways
- Personal loans can be used for almost any purpose.
- According to an Investopedia survey, debt consolidation is the top reason people take out a personal loan.
- Unlike home mortgages and car loans, personal loans are usually not secured by collateral.
- Personal loans can be less expensive than credit cards and some other types of loans, but more expensive than others.
How Personal Loans Work: When Are Personal Loans a Good Idea
A personal loan is typically an unsecured loan, which means that the lender does not require collateral—a home or a car, for example—to borrow money. However, with unsecured loans, the lender takes a greater risk and will most likely charge a higher interest rate than a secured loan. How high your rate will be can depend on several factors, including your credit score and debt-to-income ratio.
Some banks offer secured personal loans; the collateral can be your bank account, car, or other property. A secured personal loan may be easier to qualify for and carry a somewhat lower interest rate than an unsecured one. As with any other secured loan, you may lose your collateral if you are unable to keep up with the payments.
Even with an unsecured personal loan, failing to make timely payments can harm your credit score and severely limit your ability to obtain credit in the future. FICO, the company behind the most widely used credit score, says that your payment history is the single most important factor in its formula, accounting for 35% of your credit score.2
When Are Personal Loans a Good Idea: When To Consider a Personal Loan
Before you opt for a personal loan, you’ll want to consider whether there may be less expensive options to borrow money. Some reasons for choosing a personal loan are:
- You don’t have or couldn’t qualify for a low-interest credit card.
- The credit limits on your credit cards don’t meet your current borrowing needs.
- A personal loan is your least expensive borrowing option.
- You don’t have any collateral to offer.
1. Consolidating Credit Card Debt
If you have large balances on high-interest credit cards, a personal loan can help you save money.
As of April 2025:
- Average credit card interest rate: 24.20%
- Average personal loan interest rate: 11.66%
Using a personal loan to pay off credit cards could reduce interest costs and make it easier to manage by combining multiple payments into one.
Example Savings Table
| Credit Card Balance | APR | Monthly Payment (Est.) | Total Interest Over 3 Years |
|---|---|---|---|
| $10,000 (credit card) | 24.20% | $400+ | ~$4,300 |
| $10,000 (personal loan) | 11.66% | ~$330 | ~$1,800 |
2. Paying Off Other High-Interest Debts
If you’re stuck with payday loans or older personal loans with high rates, switching to a lower-rate personal loan can save you money.
Before refinancing or replacing a loan:
- Check for prepayment penalties on your existing loan.
- Look out for origination or application fees on the new loan.
3. Financing a Home Improvement or Large Purchase
Need to buy appliances, install heating, or renovate your home?
- A personal loan may be cheaper than store financing or using a credit card.
- If you own a home, consider a home equity loan — which often comes with lower rates but does require putting your home up as collateral.
4. Paying for a Major Life Event
Events like weddings, anniversaries, or religious ceremonies are meaningful — but expensive. A personal loan can help if you don’t want to use high-interest credit cards.
Cost Example: Wedding
| Item | Approximate Cost |
|---|---|
| Venue & Catering | $10,000 |
| Photography | $2,000 |
| Attire | $1,500 |
| Entertainment | $1,000 |
| Total | $14,500 |
If possible, try to reduce costs or save in advance to avoid long-term debt.
5. Improving Your Credit Score
A personal loan may help your credit in two main ways:
- If you make all payments on time, it shows lenders you’re responsible.
- It adds variety to your credit profile, improving your credit mix.
However, don’t take out a loan just to improve your credit. Only borrow if you need to, and always keep your credit card balances low.
How People Actually Use Personal Loans
A recent survey (2023) showed how borrowers in the U.S. used personal loans:
| Use Case | % of Borrowers |
|---|---|
| Debt consolidation | 48% |
| Home improvement | 29% |
| Major purchases | 11% |
| Medical expenses | 5% |
| Other | 7% |
When Should You Not Use a Personal Loan?
Most lenders do not allow personal loans to be used for the following:
- Paying for college tuition or student loans
- Making a down payment on a home
- Starting or funding a business
- Investing in stocks or crypto
- Gambling or betting
