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Personal loans, which are unsecured installment loans, are becoming increasingly popular, for reasons that include their relatively low interest rates compared with other borrowing alternatives. While personal loans can be used for almost any purpose, some purposes make more financial sense than others. Here’s a look at when taking out a personal loan makes sense--and, just as importantly, when it doesn’t.
Consolidating or Paying Off Debt
Consolidating or paying off high interest debt is the most common reason people turn to personal loans--and also one of the smartest. A personal loan allows you to streamline multiple payments from other debts into a single monthly payment with a lower interest rate than you’re paying on those other obligations. Many credit cards, for instance, have APRs between 15% and 20%. In contrast, personal loans can have rates as low as 5% or 6%. That difference can result in a dramatic drop in interest payments.
Home Improvement
Using a personal loan to make a long-term investment qualifies as “good debt,” because you could earn more than you’re borrowing in the long run--in this case, through an increase in the value of your home. While most personal loans can be used for home improvement projects, you should also consider a home equity loan or line of credit. Since those alternatives use as collateral the equity you have in your home, you may be able to score a lower interest rate than with a plain-vanilla personal loan.
Career or Educational Development
Like borrowing to renovate, using a loan to invest in your career or education could reap dividends down the road, by raising your qualifications and boosting your income. While most personal loans cannot be used to pay tuition for college or university classes, they can be used for other educational or professional-development endeavors. For example, some online lenders, like Upstart and Pave, provide financing to students who are enrolled in educational bootcamps, such as Dev Bootcamp or General Assembly.
When Should You NOT Use a Personal Loan?
While a personal loan can be used for virtually any purpose, there are instances where a personal loan isn’t a wise financing option. Here are a few of those:
Weddings, Honeymoons or Vacations
Taking on debt for these, or almost any other consumer products or expenditures, is generally a bad idea. Not only will you be stuck paying for your vacation or wedding for years to come, but this strategy also encourages bad financial habits, since it’s better to save for such expenses than to borrow for them. And in the case of wedding loans, the loan sometimes outlasts the marriage! Most financial experts agree that if you must borrow to pay for such expenses, you can’t afford them.
Medical Bills
Faced with a hefty medical bill, a personal loan may seem like a godsend. However, there are several reasons to pause before even considering such a loan. The first is that you can usually work out a payment plan directly with your medical provider, thus allowing you to skip paying interest on the debt. Further, medical bills sometimes evolve downward as all-too-common errors are found. If you take out a personal loan only to find you owe less, you’ll be stuck paying interest on the extra amount.
Car Purchase or Refinancing
A personal loan can be used to buy or refinance a car, but it isn’t an ideal option. You’re better off getting a traditional auto-purchase or auto-refinancing loan. Because these loans are secured by collateral -- that is, your car -- they have lower rates than personal loans, which are typically unsecured. For comparison, we found that for borrowers with excellent credit the average rate on a personal loan is 10.3% and the rate on an auto loan is 3.6%.
This content originally appeared on ValuePenguin.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
