3 Times a Personal Loan Is a Seriously Bad Idea

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Personal loans are a helpful tool. But read on to see when taking one out is a poor choice. 

There’s a reason personal loans tend to be popular with consumers. A personal loan allows you to borrow money for any purpose.

Need to fix up your car? You can use your loan proceeds to make repairs. Want to improve your living space? A personal loan can make that possible, too.

One benefit of taking out a personal loan is that you’re likely to get your money quickly. Rocket says these loans commonly close in seven business days or less.

But there are some situations where signing a personal loan is a poor choice. Here are three such scenarios.

1. When you’re buying a home

Generally speaking, you cannot use a personal loan to come up with a down payment on a home. Most conventional mortgage lenders will not allow you to do this, says Experian. And the same holds true for FHA lenders.

However, Experian notes that some lenders might technically allow you to use a personal loan for a home down payment. But even so, going this route could be challenging.

Taking out a personal loan for a down payment on a home will add to your debt. And a big factor that mortgage lenders look at when evaluating loan candidates is their debt-to-income ratio, which measures how much debt you have relative to your income. If a personal loan drives that ratio way up, your chances of getting mortgage approval go way down.

2. When you’re buying a car

You may be able to use the proceeds from a personal loan to buy a car. But signing an auto loan could result in a lower interest rate.

Personal loans are unsecured, so they’re not tied to a specific asset. As such, lenders take on a fair amount of risk when writing them.

Auto loans, on the other hand, are secured by the vehicles they’re used to finance. Auto loan lenders know that if a borrower defaults on their loan, they can repossess the vehicle being financed to get repaid if needed. Because auto loan lenders have that protection, they can commonly offer lower interest rates than what personal loan lenders can.

3. When you’re buying something you don’t need

A personal loan allows you to borrow money for any purpose. But that doesn’t mean you should borrow for something that’s a pure want, like a vacation or a wardrobe update (assuming you don’t need one for work).

Falling behind on a personal loan could cause serious damage to your credit score. And remember, you’re still borrowing money and paying interest on that sum. So if you’re going to subject yourself to those monthly payments, it should be because you needed to borrow, such as to fix your roof — not because you simply wanted something you couldn’t afford.

Signing a personal loan could be a good solution when your vehicle needs work or you’re looking to consolidate other more expensive debts, like credit card balances. But be very careful when taking one out, and aim to do so for the right reasons.

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