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Loans

Should you use a personal loan to fund your holiday shopping? Here are the pros and cons

Select breaks down some advantages and disadvantages of personal loans, and some alternatives.

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The holidays are right around the corner — and they might be at the forefront of your mind if you haven't already checked off everything on this year's holiday shopping list.

Spending around the holidays tends to increase as you're buying gifts for loved ones, traveling to be with your family and even spending for your holiday meals. In fact, according to a report from the National Retail Federation, Americans may expect to spend an average of $998 this year on holiday shopping, food and decorations.

Holiday shopping for many people can be expensive, and even borderline unaffordable. However, there are some options that can help make preparing for the holidays feel like less of a financial burden this year. One option is taking out a personal loan, which can be used to cover just about any expense. Borrowers typically use a personal loan to pay for a wedding, vacation, home improvement, funeral, debt consolidation and more.

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At the same time, though, you should be careful to never borrow more than you can afford. The more you apply for, the more you'll have to pay back with interest. And, you should only take on a personal loan if you have a plan for how you'll afford the monthly payments.

In addition to flexibility, there are some other major advantages to using a personal loan to cover a large expense like holiday shopping. Below, Select breaks down some key advantages and disadvantages you should know when it comes to taking out a personal loan, as well as some alternatives to fund your holiday shopping if you don't think personal loans are the right fit for you.

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Pros of using a personal loan for holiday shopping

Quick funding

Lenders typically disburse funds directly to your bank account so you can start using that money as soon as possible. In fact, some lenders will even get you funded as early as the very next day after you've been approved. Just make sure you provide complete and accurate information on your application to avoid any processing delays.

The opportunity to borrow small amounts of money

Even if you won't need thousands of dollars to fund your holiday spending, you can still qualify for a loan for smaller amounts of money. There are a few lenders that let you borrow as little as $1,000 — like Upstart Personal Loans. However, PenFed Personal Loans actually lets you borrow as little as $600 (you'll just have to create an account with them to receive the funding).

The best way to figure out how much money you should borrow is to calculate how much it'll cost to make all the holiday purchases you'll need. Then apply for that amount — make sure you don't take on a loan that's larger than you'll actually need because you'll have to pay it all back, plus interest.

Lower interest rates compared to credit cards

Personal loans are known for being a more affordable alternative to credit cards because they typically carry lower interest rates. Personal loan APRs average 9.58%, according to the Fed's most recent data. By contrast though, the average credit card interest rate is around 16.30%.

It could potentially increase your credit score

Taking on a personal loan can help improve your credit mix. Your credit mix refers to the different types of credit accounts you have, including credit cards, loans, mortgages, etc., and it makes up 10% of your credit score.

It's not necessary to have one of each type of account, but having a variety of accounts can show lenders that you can manage multiple types of credit. This can help you get approved for different types of accounts and get lower interest rates, as financial institutions are more likely to see you as a more creditworthy borrower when you apply for a new form of credit, like a mortgage or car loan. Just make sure you're not taking on too much debt at any given time.

Options to repay the loan over longer periods of time

The term of the loan refers to the amount of time you have to repay the loan completely. Different lenders offer different terms but you can generally have as long as five to seven years to repay the loan. This can be useful if you think you'll need a little longer to repay the amount you borrow. And, a longer term usually means smaller monthly payments, however, be aware that it could also mean paying more in total interest charges.

Cons

Potentially higher interest rate, depending on your credit score

When applying for any form of debt, including personal loans, your creditworthiness is always taken into account. In other words, lenders look at your credit score to determine what kinds of terms they can offer you, including the interest rate you'll have to pay on the loan.

A higher credit score means that you could qualify for interest rates on the lower end of what the lender offers. But a lower credit score means that you'll end up paying an interest rate on the higher end of their range. There are even personal loans aimed at people with poor or fair credit but just be sure to double check that the interest rate is one you'll be comfortable with.

A prepayment fee for paying off the loan early

It's generally a good idea to try to pay down your debt as early as possible. But when it comes to personal loans, it may not always be a good idea. That's because some lenders charge a prepayment penalty, also known as an early payoff fee. You get hit with this fee if you pay off your loan earlier than you're supposed to.

The prepayment penalty might be calculated as a percentage of your loan balance, or as an amount that reflects how much the lender would lose in interest if you repay the balance before the end of the loan term. The calculation method varies from lender to lender, but any prepayment penalties would be stated in your loan agreement.

Not all lenders charge a prepayment penalty. In fact, there are some that don't — like SoFi Personal Loans and LightStream Personal Loans.

Some lenders may also charge origination fees and late payment fees, so be sure to read the terms of the loan agreement so you're aware of any and all fees.

You need to be able to make the monthly payment in full

With credit cards, there's typically a small required minimum amount that you must pay toward your balance each month. However, you can always pay more. With a personal loan, though, your payments are charged as fixed, equal monthly amounts with interest.

Some lenders may charge a fee for not paying that amount in full each month. So you'll need to work with your lender to make sure that your monthly payment amount suits your budget. They may be able to adjust your repayment period so you have more time and a smaller monthly amount, though, that would also mean paying more in interest charges.

Missing a payment or making a late payment could hurt your credit score

Be careful to avoid making late payments on your personal loan. Missing a payment or making a late payment could cause your credit score to take a hit, but this also goes for pretty much any form of debt, not just personal loans.

That being said, if you're worried about a change in your circumstances in the near future that could cause you to miss a loan payment, it may not be a good idea to apply for a personal loan.

And to avoid the likelihood that you'll accidentally miss a loan payment, you can enroll in autopay to have payments automatically deducted from your bank account each month. Lenders that offer an autopay option also typically offer a small 0.25% reduction in your interest charges, which may not sound like a lot, but it can go a long way over time.

Alternatives to using a personal loan for holiday shopping

A credit card with an interest-free intro period

Some of the best credit cards offer introductory periods after opening a new account where you won't be charged interest on new purchases (or balance transfers, or both) for up to 21 months. This means that you can make purchases and repay your balance without any interest charges for the specified time frame. This can save you some money when you consider the fact that the average interest rate for a credit card is 16.13%.

The Wells Fargo Reflect® Card offers an introductory interest-free period of no-interest financing for the first 18 months from account opening; with an extension for three months (totaling up to 21 months) with on-time minimum payments during the intro period from account opening on your purchases or qualifying balance transfers (then, 16.74% - 28.74% variable APR). Balance transfers made within 120 days qualify for the intro rate and fee. (See rates and fees) This card doesn't come with any perks like points or cash back, but if you want a card that does, you might look at the Chase Freedom Unlimited®. The interest-free period on purchases and balance transfers for this card lasts 15 months (then a 17.99% - 26.74% variable APR.) There's an intro balance transfer fee of either $5 or 3% of the amount of each transfer, whichever is greater, on transfers made within 60 days of account opening. After that it's either $5 or 5% of the amount of each transfer, whichever is greater. You can get an unlimited 1.5% cash back on all purchases — including all the holiday gifts you need to buy.

Buy now, pay later

If a personal loan or credit card doesn't fit into your holiday spending plan, another alternative to consider is a buy now, pay later service (BNPL for short). BNPL, which is also known as a point of sale loan, allows you to split up the cost of your purchases over time. So let's say you want to make a $100 purchase; instead of paying $100 upfront today, you might use a BNPL service to make four payments of $25 over the course of a few weeks.

Affirm, one BNPL service, lets you repay your loan in as little as one month and as long as 48 months with up to 30% interest (Affirm doesn't charge late fees, but late or missing payments could affect your ability to use the service in the future). Afterpay, another popular service, only allows you to make four payments over the course of six weeks, but you won't accrue any interest charges.

For most BNPL services, you won't need a hard credit check to qualify, however, using a service could still affect your credit score even if you make all your payments on time.

Every BNPL loan that you take out shows up as a separate account on your credit report. When you take out a short-term loan and then pay it off, you're "closing" the account and in-turn decreasing the average age of your credit history. This is factored into your length of your credit history, which makes up 15% of your FICO score. So opening BNPL loan accounts and then effectively closing them when you pay them off could have a negative impact on your credit score.

The only way around this is to use a BNPL service that doesn't report to the credit Bureaus, like Afterpay.

Similar to personal loans, BNPL options may not be for everyone, but if you do decide to move forward with this option make sure you fully understand the service provider's terms.

Bottom line

If you're in need of some holiday funding, personal loans may offer a solution. However, it's important to be aware of some of their unique advantages — like next-day funding and lower interest rates — and their disadvantages, including prepayment penalties. If you do want apply for a personal loan, you can compare options in our best personal loan list or best personal loans for quick funding.

Keep in mind that you should avoid applying for a loan that's larger than you can actually afford. And before you apply, make sure you have a plan in place for making the monthly payments.

And even if you decide personal loans aren't the best way to help you afford your holiday shopping list, you might still consider some alternatives, like using a credit card with an interest-free intro period or using a BNPL loan.

Catch up on Select's in-depth coverage of personal financetech and toolswellness and more, and follow us on FacebookInstagram and Twitter to stay up to date.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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