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Taking out a personal loan can be a smart decision in some circumstances. Keep reading for the situations where you should avoid them.
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A personal loan can be used for almost anything you want. And because the money is usually deposited right into your bank account when you’ve been approved, it can be more flexible than a credit card, as you may not be able to charge every purchase on a card.
But just because a personal loan is a flexible funding option doesn’t necessarily mean you should take one out for any reason. There are good and bad reasons to borrow using this type of financing. Here are some of the best and worst reasons to use a personal loan.
These are the best reasons to take a personal loan
Here are some scenarios where taking out a personal loan is likely a good idea:
Debt consolidation
Debt consolidation is a great use for a personal loan because it can save you money over time. Say you have a $4,000 credit card balance at a 21% interest rate you’re paying $100 a month toward and a $3,000 balance at 18% with $75 monthly payments. If you can consolidate to a new personal loan at 12.23% for 48 months, your monthly payment will be almost the same ($185.11), but you’ll save $2,669.72 over time in interest and reduce your payoff time by 1.78 years.
Financing an essential purchase
If you must buy something before you can pay cash for it out of your checking account, a personal loan could be a better way to do it. Say you needed $5,000 for a home repair and had a choice between using a personal loan at 12.17% (the average interest rate) or a credit card at 21.19% (the average rate for cards, according to the Federal Reserve Bank of St. Louis). You could take out a three-year personal loan, make payments of $166.48 per month, and pay $993.20 in total interest. Or you could use a credit card. If you used a card and made the same $166.48 monthly payments as a loan would’ve required, it would take you three years and eight months to be debt free and you’d pay a total of $2,187.86 in interest over time.
As you can see, in both of these situations, you end up financially better off if you took out the personal loan compared with the alternative. While it would be better to pay cash for your essential purchase or to pay off your debt quickly, doing those things isn’t always possible. If you’re in a situation where you need to reduce your interest or to pay for something right away that you can’t afford, a personal loan can be a good way to do it.
These are the worst reasons
Unfortunately, there are also some bad reasons to take a loan. Here are two of the worst.
Paying for vacation
Vacations are fun, but they are generally not worth going into debt for because they aren’t really a necessity. Rather than making your vacation more expensive by paying interest for it, just take a cheaper trip you can pay for with your savings. Or consider setting a goal to build a big vacation fund so you can go where you want without getting stuck with debt you’ll be paying long after the trip is over.
Funding a lifestyle you can’t afford
You cannot borrow your way out of a budget shortfall. You’ll be constantly in debt and will only make your future situation worse. Instead, look at cuts you can make and start living within your means ASAP. Consider increasing your income to support your spending, too.
Before taking a personal loan, you should always ask yourself if doing so will leave you better off over the long term. If not, then skip the borrowing and look for a different option, such as saving up for a purchase or cutting your costs to free up more money in your budget.
Our picks for the best personal loans
Our team of independent experts pored over the fine print to find the select personal loans that offer competitive rates and low fees. Get started by reviewing our picks for the best personal loans.
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