Advantages and Disadvantages of Personal Loans?

Answer 1

When choosing a personal loan it is important to note that often small but significant differences exist between the loans on offer, and as a result some types will be more suited to your individual circumstances than others. These differences may include flexibility, repayment terms, insurances offered and how established the lender is.

It can be difficult to remain objective when you are in need of money, but if you fail to consider the risks associated with borrowing you may end up regretting a commitment to a high interest rate or demanding repayment schedule. When you have a clear idea of the advantages and disadvantages of loans in general, comparing the loans on offer will prove easier. Consider the disadvantages you are prepared to accept, such as higher interest over a shorter repayment period, if you are keen to pay the loan off quickly.

Advantages of a Loan

Loans are a relatively fast way to obtain funds for a special purchase or project, and even large amounts can be borrowed for almost any purpose. They are suitable for expensive purchases that require immediate payment, allowing you to spread the cost of the purchase and manage your short term finances more easily, especially if your loan has a fixed interest rate (see Interest Rates).

There is a high level of competition amongst lenders, which usually makes it possible for you to negotiate a cheaper interest rate than the one which you are initially quoted. It may also be worth investigating whether there is a specialist lender who can provide loans tailored to your specific purpose, for example buying a car, since they may offer you a cheaper or more suitable loan. Personal loans are often more popular than other sources of finance such as credit cards and overdrafts, because the amount you can borrow is typically greater.

Disadvantages of a Loan

Loans constitute a long-term financial agreement and used in the right way can be a useful financial tool. However, anyone considering applying for a loan should analyse their personal finances carefully, and calculate exactly how much they can afford to borrow based on how much money they can spend on repayments each month, once their other financial committments have been honoured.

If you cannot afford to make repayments when they are due, you may face a penalty. If you have chosen to take out a secured loan, you may even lose your home. For this reason it is important to read all the 'small print' of any loan contract to see what penalties could be levied, and consider whether or not you should be applying for a loan at all. Furthermore, if you default on the loan, your credit rating and ability to access credit in the future will be detrimentally affected, see Credit Scoring.

On the other hand, you could also be penalised for making a large lump sum repayment to pay off your loan sooner than agreed. Although most loan companies will allow you to do this, they may charge you an early repayment fee.

For anyone wishing to borrow only a small amount that they aim to pay back within a short period of time, acredit card may be a more suitable solution because the balance can usually be paid off in full at any time without incurring early repayment fees. Similarly, an overdraft may be a more effective option for those who require a relatively small amount of credit in an emergency. However, interest charges for overdrafts and credit cards are usually much higher than for personal loans, so it is inadvisable to use them for long-term borrowing.