Personal Loans: When to Borrow and How Much You Can Afford

Personal loans can be a valuable financial tool for consolidating debt, making large purchases, or covering unexpected expenses. However, borrowing responsibly requires understanding when a personal loan makes sense and how much you can truly afford. This guide will help you make smart decisions about personal loans.

Test payment, rate, and term combos with /finance/loan-calculator before you apply.

What Is a Personal Loan?

A personal loan is an unsecured loan (no collateral required) that you borrow from a bank, credit union, or online lender. Unlike auto loans or mortgages, there's no specific asset backing the loan—it's based on your creditworthiness.

Typical Characteristics:

• Fixed monthly payments
• Fixed interest rates
• Terms from 12-84 months
• Loan amounts from $1,000-$100,000+

When Should You Get a Personal Loan?

Personal loans are appropriate in these situations:

1. Debt Consolidation

• You have multiple high-interest debts (especially credit cards with 15-25% APR)
• You can qualify for a lower interest rate
• You can reduce your total monthly payment
• You have the discipline not to run up credit card balances again

2. Large Necessary Expenses

• Home improvements that add value
• Medical bills (sometimes with lower interest than medical credit cards)
• Moving expenses
• Necessary car repairs
• Other unavoidable significant expenses

3. Major Life Events

• Weddings (if you can't save for it)
• Medical emergencies
• Starting a business (with a solid plan)
• Education expenses

Personal loans are NOT appropriate for:

• Lifestyle inflation you can't afford
• Vacations or non-essential purchases
• Daily expenses you can't cover
• Gambling or speculative investments
• Paying for things you should have budgeted for

How Much Can You Afford to Borrow?

Determining how much you can afford to borrow requires careful calculation:

The 28/36 Rule

Financial experts recommend that:

• Total housing costs (including mortgage/rent, utilities, insurance) should be ≤28% of gross income
• Total debt payments (including the new personal loan) should be ≤36% of gross income

Detailed Calculation

Step 1: Calculate Your Income

• Monthly gross income (before taxes)
• Or monthly take-home pay after taxes and deductions

Step 2: List Your Existing Debt Payments

• Mortgage or rent
• Auto loan
• Credit card minimum payments
• Student loans
• Any other loans
• Add them all up

Step 3: Calculate Available Income

• Your monthly net income
• Subtract existing debt payments
• Subtract necessary expenses (food, utilities, insurance, gas)
• What's left is your available income for a new loan payment

Step 4: Use Our Loan Calculator Input different loan amounts to see:

• The monthly payment
• Total interest
• Whether it fits your budget

Example:

• Take-home pay: $4,000/month
• Existing debts: $800/month
• Monthly expenses: $1,500/month
• Available for loan: $1,700/month
• Recommendation: Use no more than 50-60% of available income
• Safe payment: $850-1,020/month

Use our Loan Calculator with different amounts to find what works.

The Emergency Fund Question

Before taking a personal loan, consider:

• Do you have 3-6 months of expenses saved?
• Could you save for this expense instead?
• Is the interest worth not waiting?

Borrowing to avoid dipping into emergency savings is sometimes smart, but only for true emergencies.

Interest Rates and Your Budget

Personal loan interest rates vary significantly based on your credit score:

Excellent Credit (750+): 6-10% APR Good Credit (700-749): 10-15% APR Fair Credit (650-699): 15-20% APR Poor Credit (below 650): 20-36% APR (or may not qualify)

Impact on Your Budget: On a $10,000 3-year loan:

• At 8%: $313/month, $1,269 total interest
• At 20%: $371/month, $3,367 total interest

The difference is $58/month and over $2,000 in interest! Use our Loan Calculator to see how rates affect your specific situation.

Loan Terms: Shorter vs. Longer

Shorter Terms (12-36 months):

• Lower total interest
• Higher monthly payments
• Faster debt freedom
• Lower overall cost

Longer Terms (60-84 months):

• Lower monthly payments
• More total interest paid
• Debt hangs around longer
• More expensive overall

Our Recommendation: Choose the shortest term you can comfortably afford. If you must choose between a 48-month and 72-month loan, pick 48 months and adjust the loan amount down if needed.

Red Flags: When NOT to Borrow

1. You Can't Make Minimum Payments If you're already struggling, a loan only adds to your burden.

2. It's for a Non-Essential Purchase Vacations, luxury items, or lifestyle upgrades should come from savings.

3. You Have Bad Credit and High Rates 20%+ interest rates make personal loans very expensive. Consider alternatives.

4. You Haven't Tried Other Options

• Can you cut expenses?
• Can you increase income?
• Do you really need this right now?
• Can you save for it instead?

5. You're Using It to Avoid Budgeting A loan doesn't fix overspending or poor budgeting. Address the root cause first.

Personal Loan Alternatives

Before taking a personal loan, consider:

1. Using Your Emergency Fund (if you have one)

• No interest charges
• No monthly payments
• You can rebuild the fund

2. 0% Balance Transfer Credit Card

• Often better for debt consolidation if you can pay within the promo period
• Watch out for transfer fees

3. Home Equity Line of Credit (HELOC)

• Lower interest rates (secured by your home)
• Tax benefits in some cases
• Risk: Your house is collateral

4. Asking Family

• Usually no interest
• Flexible terms
• Can strain relationships
• Treat like a formal loan

5. Saving for It

• No debt
• No interest
• Can wait?
• Builds savings discipline

Shopping for a Personal Loan

Check Multiple Lenders:

• Banks
• Credit unions (often best rates for members)
• Online lenders (often competitive)
• Compare at least 3-5 offers

Compare:

• Interest rate (APR)
• Origination fees
• Prepayment penalties
• Loan terms available
• Funding speed

Watch for:

• High origination fees (1-8% of loan amount)
• Prepayment penalties
• Hard credit checks (shop within 14-45 days to minimize impact)
• Predatory lenders targeting those with poor credit

Making the Decision

Before borrowing, ask yourself:

1. Is this necessary? Not "nice to have" but truly necessary
2. Can I afford the payment? Using the budgeting steps above
3. Have I tried alternatives? Saving, cutting expenses, increasing income
4. What's my credit score? Better scores mean better rates
5. Have I shopped around? Compare multiple lenders
6. Do I have an emergency fund? Ideally 3-6 months of expenses
7. What's the total cost? Not just the monthly payment, but total interest

Use our Loan Calculator to run scenarios for different:

• Loan amounts
• Interest rates
• Loan terms
• See total interest charges

Responsible Borrowing

If you do take a personal loan:

Make Payments On Time: Late payments hurt your credit and can trigger fees or default.

Pay More When You Can: Extra payments reduce interest and shorten the loan term.

Don't Take Out More Than Needed: Only borrow what you actually need.

Have a Plan: Know how you'll make payments and what happens if your income changes.

Don't Add More Debt: Especially important after debt consolidation—don't run up credit cards again.

Using a Loan Calculator

Our Loan Calculator is essential for making smart borrowing decisions. Use it to:

• See if you can afford the monthly payment
• Compare different loan amounts
• Understand total interest charges
• Choose between different terms
• Verify lender quotes match calculations

The Bottom Line: Personal loans can be helpful, but only when used responsibly for the right reasons. Calculate carefully, shop around, and make sure the loan improves your financial situation rather than adding unnecessary burden.