Personal loans can be a financial lifeline for many people, offering quick access to funds for everything — from a big purchase to a small emergency expense.
While a personal loan has several benefits, it also carries some inherent risks.
Understanding the pros and cons of a personal loan can help you decide if it’s the right financial tool for your situation.
Key Points:
- Personal loans offer quick access to funds for things like debt consolidation, emergencies, or large purchases.
- They can help build credit when managed responsibly but can come with high interest rates for borrowers with bad credit.
- Alternatives to personal loans include buy now, pay later (BNPL) services, low-interest credit cards, or home equity loans.
What Is A Personal Loan?
Personal loans involve borrowing a lump sum of money, which is then repaid over a set term via regular installments, with interest.
Features
| Loan Amounts | $500 up to $50,000 |
| Interest Rates | Up to 35% depending on creditworthiness and lender |
| Loan Terms | 6 months to 5 years |
Learn more: Best Personal Loans In Canada
Pros And Cons Of A Personal Loan: An Overview
Personal loans offer significant advantages and flexibility, but also come with some drawbacks.
Here’s an overview of the pros and cons:
| Pros | Cons |
| – Fixed repayment terms – Potentially lower interest rates than credit cards – Can opt for unsecured or secured personal loans – Can be used for almost anything, including debt consolidation and emergency expenses – Builds credit when managed responsibly | – Individuals with bad credit may be charged high interest rates – There may be additional fees – Risk of overborrowing – Missed payments can harm credit score – Financial inflexibility during the repayment period |
What Are The Benefits Of A Personal Loan?
As mentioned, there are many benefits of a personal loan. While some may be obvious, there are other less common ways a personal loan can come in handy.
1. Save Money By Consolidating Debt
One of the most common uses for a personal loan is consolidating high-interest debts, such as credit card balances. By replacing multiple payments with a single loan at a lower interest rate, you can save money and simplify your finances.
For example, many credit cards have interest rates exceeding 20%, while personal loans often offer rates between 9.99% to 35% for qualified borrowers.
2. Spread the Costs Of Large Purchases
Personal loans are ideal for significant one-time expenses, such as home renovations, weddings, or a new vehicle. You could spread the cost over a fixed period with manageable monthly payments.
3. Overcome Financial Setbacks
In times of financial hardship — such as job loss, medical emergencies, or unexpected home repairs — a personal loan can provide the cash you need to stay afloat.
However, it’s crucial to ensure you have a realistic repayment plan in place before you take the payout.
4. Build Credit
When used responsibly, personal loans can boost your credit score by adding to your credit mix and demonstrating consistent repayment. Timely payments signal reliability to lenders, potentially improving your credit profile over time.
5. Unsecured Vs Secured Personal Loans
While personal loans are often unsecured, you may have the option to take out a secured loan. A secured personal loan is backed by collateral, like a car. This reduces the lender’s risk and may result in a lower interest rate, a higher loan amount, and a higher likelihood of approval.
| Warning: If you use collateral for a personal loan, you risk losing that asset if you fail to keep up with your loan payments. |
Learn more: Unsecured vs. Secured Loan: What’s The Difference?
6. Personal Loans Can Help During Different Life Stages
A personal loan can also be helpful to individuals in different circumstances:
For Young Professionals and Students
Personal loans offer quick access to funds for emergencies, education, or starting a business.
Do note, high interest rates and the risk of overextending financially can burden young borrowers before they’ve established a stable income. Interest rates are affected by credit history, which is limited for younger individuals.
For Retirees or Pre-Retirees
Personal loans can help retirees pay off lingering debts or manage unexpected expenses, reducing financial stress during retirement.
Those on a fixed income may find repayment more challenging, and borrowing at this stage may indicate deeper financial issues.
Learn more: How To Get A Loan When You’re Retired
What Are The Risks Of A Personal Loan?
- High Interest Rates: Borrowers with poor credit may face interest rates upwards of 20%, negating the benefits of the loan.
- Additional Fees: Origination fees, late payment penalties, and prepayment penalties can increase the total cost.
- Credit Score Impact: Missed payments can damage your credit score and lead to debt collection.
- Reduced Financial Flexibility: Loan repayments can tie up a portion of your income for months or years, limiting your ability to save or spend on other needs.
- Mental Health Impact: Financial stress from managing debt can affect mental well-being. Having looming bills or the inability to make a loan payment may cause stress.
- Risk of Overborrowing: At first glance, it seems easy to access funds. This may lead to borrowing more than you can afford to repay, creating a false sense of financial freedom.
- Changing Financial Circumstances: A job loss or medical emergency during the loan term could affect your ability to repay.
Where Can You Get A Personal Loan?
You can get a personal loan from several sources, each with different requirements and benefits.
Banks
Banks and credit unions are traditional options, offering competitive rates to borrowers with strong credit.
Online Lenders
Online private lenders provide faster approvals and flexible terms, often catering to those with lower credit scores. However, loans from these lenders carry higher interest rates. Ultimately, the best source depends on your credit score, income, and how quickly you need access to funds.
How Do You Qualify For A Personal Loan?
Personal loan qualifications typically include the following:
When applying for a personal loan, lenders typically review several key factors to determine your eligibility, including the following:
- Credit Score: Your credit score plays a major role in the approval process. The higher your score, the better your chances of securing a lower rate and more favourable terms. Most lenders look for a minimum score of around 660.
- Income: Lenders want to ensure you earn enough to manage loan payments alongside other financial obligations you have. The exact minimum income requirement can vary depending on the loan size and the lender’s policies.
- Employment Stability: Many lenders prefer applicants who have been employed for at least three to six months. Some may accept alternative income sources like pensions or government benefits if they are reliable.
- Debt-To-Income Ratio: Ideally, your DTI ratio should not exceed 44%. If too much of your income is already committed to debt repayment, approval may be difficult.
Learn more: How To Get Approved For A Personal Loan: Personal Loan Requirements
When Should You Get A Personal Loan?
The best time to take out a personal loan is when you have a clear plan for its use and repayment. Ideal scenarios include consolidating high-interest debt, spreading out the cost of a necessary purchase, or covering unexpected expenses.
Ensure that the monthly payments fit comfortably within your budget and that the total cost of borrowing aligns with your financial goals.
| Tip: Create a budget to ensure that the monthly expense of the personal loan is manageable before taking out a personal loan. This can cut down the risk of overborrowing and potentially missing a payment—and consequently damaging your credit score. |
What Can I Use A Personal Loan For?
You can use a personal loan for various anything, but some of the more common reasons include:
- Debt consolidation
- Home renovations
- Car repairs
- Medical expenses
- Major purchases (like appliances or furniture)
- Education costs
- Travel
- Weddings
- Investments
Alternatives To A Personal Loan
Other financial options you may wish to explore before applying for a personal loan include the following:
| Buy Now, Pay Later (BNPL) | Ideal for smaller purchases, BNPL plans allow you to split payments over several months, often with no interest if payments are made on time. |
| Balance Transfer Credit Cards | Balance transfer credit cards with introductory 0% APR periods can help you consolidate debt without incurring interest—provided you pay off the balance before the promotional period ends. |
| Home Equity Loans | If you own a home, a home equity loan or line of credit (HELOC) may offer lower interest rates and larger borrowing limits. However, your home serves as collateral, increasing the risk if you default. |
| Small Credit Lines & Cash Advances | If you only need a small amount of money and don’t have the credit score to qualify for a personal loan, consider small credit lines and cash advances, such as: – Nyble – Bree – KOHO Cover – MoneyUp |
Bottom Line
Personal loans can be a valuable financial tool for Canadians when used wisely. However, they also come with risks that you should be aware of, including high interest rates and added debt. Before taking out a personal loan, evaluate your financial situation, explore alternatives, and ensure you have a solid repayment plan.
