Understanding the advantages and disadvantages of getting a loan is a must when considering if it’s the best course of action. Here we’ve rounded up some common pros and cons of taking on a loan when you need financing. We’re mainly dealing with personal loans here, though the pros or cons will be translatable to other loan types.
Advantages Of Loaning
Here are the advantages associated with loaning cash:
Fast Access To Cash
You’re getting a loan for a reason – because you need cash quickly. The speed of funding may vary depending on the nature of the loan and who you’re getting it from but many offer next-day funding for when you need to get cash fast. This is great for dealing with unexpected costs that may arise in personal or professional settings.
Research the entire loan application process before you start applying, so you know exactly how long it should take before you even start.
Enables Credit Building
When you take out a loan, you can then build your credit score as you pay it back. If you’re new to borrowing cash to finance your personal or business ventures, you need to understand how important your credit score is to get accepted for a loan. While many loans exist with different passing criteria, the overwhelming majority of them will demand to see if you have a credit score.
If you pay back your loan in time, your credit score increases. Of course, your credit score will be harmed if you are unable to pay the loan in time.
Clear Use For The Cash
Whether you get a personal loan or a cash advance loan, the loan type should specify what you can spend the money on. Personal loans are very versatile, to the point where you can spend them on practically anything. Loans related to business ventures, however, will often come with specifications on what they can be used for. While that’s a limitation, it does allow you to know exactly what the loan is for when planning your finances.
Lower Interest Rates Than Credit Cards
Many loans, especially personal loans, have lower interest rates than those attached to credit cards. Credit card interest rates are currently lingering around 15% while personal loan interest rates are near 12%. If you have a good credit history, you’ll be able to secure loans that have even more favorable interest rates, with some as low as 5%. Having a good credit score will also increase the amounts you can borrow.
Disadvantages Of Loaning
Of course, loaning does come with some downsides. Here are a few common ones that we can think of:
You’ll Increase Your Debt
Taking on more loans won’t help or address any debt that you already have, so loans can’t help you in those situations. Let’s say you use a personal loan to pay off credit card debt, you are just clearing debt to free up your credit limit, which you are then likely to spend in the future while carrying the loan debt, too. It’s a bad financial habit to use loans to try and pay back what are essentially other loans.
Interest Rates Aren’t Always Low
Just because the interest rate of a loan may be less than a credit card, there still may be better alternatives out there. Loans aren’t always the lowest interest rate option, especially if you’re somebody who is new to loans and has a poor credit score.
You May Have To Offer Collateral
Depending on your credit score and the types of loans you’re trying to get, you may need to offer collateral. Collateral can be cash or assets that total a certain amount, which is then secured against the loan so that if you cannot pay the loan back, you lose that cash or asset. If your credit score places doubt on your ability to pay the loan, the lender may demand collateral in some form.
The most extreme example of those would be loans secured by property, where you could lose your house or your car if you can’t make repayments on your secured loan.
Pay Attention To Fees
The fees and penalties associated with a loan may make an originally good deal undesirable, so always keep them in mind when taking on your loan. Origination fees can be as much as 5% of the loan amount.
As for penalties, some are to be expected, like penalties for not paying the loan within the agreed time frame. You should check if your loan has any prepayment penalty (typically associated with larger loans, like mortgages, where the lender could accrue interest if paid back slowly over time).