Best and Worst Ways to Use a Personal Loan
Examples of Good Personal Loan UsesIn general, you should only take out a loan of this type when doing so will allow you to better yourself substantially. Basically, you want to make sure that the money you take out will propel you toward a state where you’re more financially solvent and capable of taking care of expenses. Personal loan uses that further your career, educate you, or assist with your physical or mental well-being are noble and just reasons why you should take out a loan. Here are some examples of the best ways to use these loans that you should consider.
Education expenses:When you want to be eligible for more high-paying work, some education expenses are worth it when it comes to these loans. For instance, vocational schools are often capable of placing you in a high-paying job after just one or two years of attendance, and business schools or graduate degrees can often translate into a higher salary after graduation. Educational pursuits that make you more equipped to make money are perfect examples of justifiable applications of your personal loan funds.
Consolidating your debt:If you’ve racked up a lot of credit card debt, a personal loan might be right for you. Credit cards have incredibly high-interest rates, so if you have a large amount of debt on a single credit card or you have significant amounts of debt spread across a number of cards, it might make sense to consolidate this debt with a loan. These loans generally have low-interest rates; if your credit score is high, it might be possible to get a personal loan with an interest rate as low as 10 percent. By contrast, some credit cards can have interest rates as high as 25 percent, which means that paying off your credit card debt with your personal loan can help you save a lot of money if you don’t see yourself being able to pay off your interest for a while. Of course, it’s always best to apply the money you receive from a loan toward making yourself more financially solvent in the long term, but these loans can also be used for short-term purposes.
Fixing up your house:When your house is in great condition, it is worth more. If you’ve been putting off necessary home repairs for a while because you feel like you don’t have the resources to handle renovation expenses, then you may want to take out a loan. Whether you’re planning to sell your house soon or keep it for a long time, if you keep it in good shape, your overall net worth increases, which means that you have more financial leverage if a crisis hits. For instance, you can take out a second mortgage on your home if you need money for medical expenses or other purposes, and the amount of money you get for your mortgage depends on the condition of your house. Money used to improve the quality of your home translates almost directly into potential wealth, which makes home renovations one of the best ways to use your personal loan.
Making yourself more eligible for work:Whether you need to buy a new suit or pick up a professional pair of shoes, the right appearance could make it easier to land the type of job that you deserve. If you move on from your current position to a job that pays more, you’ll be better able to take care of any debt you may have accrued, and it will be less likely that you’ll need to take out a personal loan again in the future. It’s also justifiable to use your personal loan to pay for training programs specifically related to your job, but self-help or motivational coaching seminars that pep you up in general probably aren’t good uses for your hard-won resources.
Examples of Bad Personal Loan UsesFor every good use of these loans, there’s a bad use lurking in the shadows. In fact, there are far more numerous bad uses for these loans than good uses, which is what makes these types of loans potentially dangerous if you don’t know everything there is to know them before taking one out. In general, uses that only perpetuate the practices that got you into your current financial situation are not to be pursued, and some uses that may seem to be edifying can actually land you in an even deeper financial rut than the situation you’re currently enduring. These loans shouldn’t increase your overall spending, and they should never be used as a crutch if you already have a problem with spending too much.
Vacations:While it might seem like getting away from it all is just the thing to reset yourself and get back in the swing of things with a fresh mindset, using a loan to go on vacation is one of the worst ways to use your borrowed money. While even the best vacation will only last for a week or so, the debt from such an adventure can last for months or even years, which means that you’ll be paying off your brief bit of fun for far too long. When you’re trying to remake yourself and fix your financial outlook, vacations are nothing more than escapism; it’s best to save the fun until after you’ve gained the ability to meet your financial challenges head-on.
Consumer goods:The allure of consumer goods is one of the main reasons why people end up with significant credit card debt. Consumer goods can derail your spending decisions when you take out a personal loan, and you shouldn’t use the money to buy the latest gadgets or other goods. It’s important to remember that most consumer goods aren’t necessary for your health or well-being, and many manufacturers use complex marketing methods to make it seem like this isn’t the case. The exception when it comes to using your personal loan for consumer goods is when you’re buying goods that directly add to your ability to get a job or increase your earnings.
Fancy events:Many grooms and brides pay for the weddings of their dreams with loans. However, the best way to set yourself up for a happy, peaceful marriage is to keep things simple and pay for your wedding with your own money. The glitz and glamour of an expensive wedding will soon wear off once you confront the debt that your event has generated, and these expensive events can even create a strain in your marriage. The same goes for fancy birthday parties and graduation celebrations.
Drugs and alcohol:Spending your borrowed money on drugs and alcohol is one of the worst ways to use your loan. Any addictive substance should be avoided when you feel like you’re flush with cash after getting your loan. These substances can quickly become seemingly indispensable parts of your life, and you might find yourself justifying any and all expenses to keep the flow of drugs and alcohol coming. There is simply no circumstance under which it makes sense to pay for addictive substances with your personal loan.
Important Considerations to MakeBefore you take out a personal loan, you should understand that most of these loans are unsecured, which means that you don’t have to provide a down payment to receive the funds. Because you don’t provide down payments with these loans, they generally come with higher interest rates, and loan officers may also charge higher fees for these types of loans. Since you may not be very optimistic about your ability to pay back your personal loan quickly, it’s common to choose to take out a loan with long terms. However, short-term loans are always preferable because you’ll end up paying less interest on loans that you don’t hold for as long. Also, you should understand that some lenders are better than others. If a lender seems extremely interested in giving you a personal loan, you should be cautious. Lenders sometimes use a financial tactic called arbitrage to get more out of the loan than you do; in fact, even when you work with the most reputable loan providers, the institution getting the loan usually gets more out of the arrangement than you do. To make sure that you get the best possible deal, you should work with established national banks or reputable local credit unions. In addition, it’s important that you examine your debt-to-income ratio before you consider taking out a loan. This ratio is determined by the relationship between your monthly income and the amount you’ll need to pay on your loan each month. For instance, if you make $3,000 per month and you have monthly loan payments of $1,000, your debt-to-income ratio is $1,000/$3,000, which means that 33 percent of your monthly income will go toward paying off your loan. For most people, a debt-to-income ratio this high is unfeasible. You can achieve a reasonable ratio if you make sure that your loan payments don’t constitute more than 10 to 15 percent of your overall monthly income.
Personal Loan AlternativesIn some cases, it might make more sense to open a credit card than take out a personal loan. As we’ve mentioned, credit cards generally have higher interest rates than these loans, but if you plan to pay back your credit card debt rapidly, you might not have to worry about interest all that much. Some credit cards offer opening deals with no interest, but you’ll want to make sure that you carefully examine the terms of a prospective credit card before making a contract. In addition, family members who are doing well financially may be willing to offer you a loan. When you get a loan from a family member, there’s no financial institution that you have to work with, and you’ll figure out the terms of your loan on a person-to-person basis. While the terms of these types of loans depend on the quality of your relationship with your family member, you generally pay less interest when you borrow money from someone you know. If you have a 401k account, you can borrow money from your retirement savings. While this approach might seem attractive, remember that you’re taking away from money that you can use later in life when you withdraw from your 401k.
Should You Take Out a Personal Loan?In the end, you’ll need to carefully consider your reasons for taking out a loan. If you’ve revised your spending practices and you just need a little boost to get yourself out of your current hole, a loan might be right for you. However, if you’re considering taking out a loan because you don’t have enough income for your spending or you want to buy a lot of consumer goods, its best to resolve your spending issues before you consider borrowing any amount of money from a financial institution.
Chris Fuller went to the University of South Florida and has worked in the financial sector for over 20 years. He has extensive experience in all aspects of personal and small business lending, from personal loans, equipment finance to cash flow based solutions for small mom and pop businesses, and large corporations.