Personal loans have been around for generations and are the most diverse type of loan in terms of their application.
Australian’s use their personal loans on myriad of purchases, both business and household. Whether it’s for an unexpected bill, medical care, debt consolidation, a new TV, or anything else of significant value, a personal loan can help you unlock the value of an asset despite not being able to afford it.
However, much like deciding whether to purchase a new tv or install a pool for the kids, there are a few essential things to consider prior to singing a contract for a personal loan!
A personal loan might not be the right product for you – weighing up the pros and cons is imperative if you want to ensure you are making smart financial decisions. Most Australian’s are familiar with personal loans on a surface level but may not understand how they differentiate with other credit products.
Fundo receives questions every day from Australians like yourself – they want to know what are the disadvantages of a short-term loan? Are they good or bad? What they should consider prior to applying and whether short or long-term personal loans are the smarter choice.
We’ll aim to answer these questions throughout the article – please remember this advice is general only and speaking to a financial professional prior to applying for any credit products is always advised.
How does a personal loan work?
A personal loan allows an individual to borrow money to pay for something or to consolidate debt. Once the lump sum is deposited into your bank account, the repayment contract is initiated and agreed amounts are debited over your term, including interest and fees.
Most lenders will offer two types of personal loans – secured and unsecured. As the name explains, a secured loan is backed by an underlying asset that holds a set value determined by the bank. The latter is not secured by any asset and is deposited straight into your account.
We’ll go over the pros and cons of secured vs unsecured later in this article but in a nutshell, secured loans will often be cheaper than unsecured.
The disadvantages of a personal loan
Let’s cut right to the chase – most people want to learn about the disadvantages first – the factors that may potentially make a personal loan the wrong option. There are three main disadvantages that are likely to cause the most issues should you enter a short-term personal loan contract.
1. Fees and interest rates can be extortionate
Personal loans are synonymous with high fees and even higher interest rates – coupled together, they drive up the cost of borrowing quite extensively. Whilst these fees can be lower than some credit cards, when compared to other loan products, they are proportionally higher.
If you have a poor credit score this may also affect the cost of your personal loan. Those with a lower credit score will be struck with higher interest rates and a smaller available balance – if you are in this boat, it may be beneficial to use portions of your savings to pay for the expenses sought after by the personal loan.
2. You’re locked in
Personal loans are essentially a contract that you sign with a financial institution – they agree to give you the money and you agree to pay it back by a certain date. This leaves little flexibility, even if you wish to pay the loan off early.
Because personal loans are short-term and charge such high interest rates – if the loan is paid off early then the bank is losing out on revenue from your interest payments. Some personal loans can be paid off early, but it all depends on what terms the bank sends.
3. Increasing Debt
As with any financial product, your debt will increase when you take on a personal loan. This could put a strain on your future financial plans like getting a mortgage or home renovation loan. Be mindful and maintain awareness when taking on more debt – it can cause immense issues in the future, should you default on a payment.
The advantages of a personal loan
Now for the exciting part, with all the disadvantages, there are still some benefits to be shared by taking on a personal loan.
1. Consolidate Debt
You can use your personal loan to pay off all other debts and roll it into one repayment schedule with a single lender. This route makes it easier to manage your debt and can lower the amount of fees and interest rates you are paying by owing to multiple lenders.
2. They can be flexible
Due to their wide-ranging application, personal loans can be flexible in some circumstances, such as if you have bad credit or only need a small amount. Most importantly, they’re easy to apply for and can be approved quickly if you’re after some fast cash.
If you’re after a cheaper loan you may opt to secure an asset such as a car or other item with significant value against the loan. Should you default, the underlying asset will be possessed to cover your downfall.
If you’re not willing to secure an asset to get a cheaper personal loan, you can choose an unsecured personal loan. Essentially, this means the money is directly deposited into your account and your personal assets aren’t at immediate risk should a default occur.
3.It may be cheaper than a credit card
Some personal loans come with lower rates than rewards credit cards – whilst you won’t get a line of credit, it may be a cheaper way to get access to credit in the short-term. This may not always be the case and your credit score will play a large role in the total cost of your loan.
We hope that you are now aware of some of the pros and cons of entering into a personal loan. It’s important to keep your mind open and consider all options and speak to a professional to determine which choice is best for you. Should you have any questions, head over the Fundo FAQ page!
Disclaimer: The opinions expressed in the Blog are for general informational and entertainment purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific investment product. It is only intended to provide education about the financial industry. The views reflected in the commentary are subject to change at any time without notice.