Personal loans are extremely versatile. They are usually not restricted to any particular purpose and in many cases, you can use them for any purpose you like. You will still have to pay them back, and you will have to assess your purpose and decide whether you want to go into debt to achieve that purpose. There are good reasons to borrow and there are also bad reasons to borrow. It’s up to you to make a wise choice!
How Do Personal Loans Work?
Personal loans are provided by banks, credit unions, online lenders, consumer finance companies, and peer-to-peer lenders. Most personal loans have some features in common:
- Personal loans are usually unsecured. You don’t put up collateral.
- A personal loan usually has a fixed term, which is the number of months or years you have to pay off the loan.
- Most personal loans have a fixed interest rate. Some may have a variable rate, so check your loan terms carefully.
- You will make monthly payments for the duration of the loan term. Each payment will include a portion of the loan principal and a portion of the interest.
- The approval of your loan and the interest rate you pay will be based on your credit, your credit history, and other factors, including your income, employment status, and other debts.
- Applying for a personal loan will generate a hard inquiry on your credit report, which can affect your credit. If you are applying to several lenders, group your inquiries closely.
- Most personal loans come with fees, including an origination fee, which may be from 1% to 6% of the amount you borrow. These fees may be deducted from your loan proceeds or divided among your monthly payments.
Interest rates on personal loans may vary widely. Major lenders may charge anywhere from 5% to 36% for an unsecured loan, depending on your credit history and financial status. Borrowers with excellent credit will usually pay from 10% to 12.5%. Borrowers with average credit can expect to pay from 18% to 20%. Consider the cost of your loan carefully before choosing to borrow.
What Are Personal Loans Used for?
A personal loan can be used for almost anything you would spend money on. These are some of the most common uses:
- Debt Consolidation. If you owe several high-interest debts (like credit card debt) but your credit is still reasonably good you may be able to take out a lower-interest personal loan, pay off those high-interest balances, and pay off the personal loan. Just be sure you don’t start spending on your cards again, or you’ll be paying both a personal loan and credit card debt.
- Paying a collection agency or other creditor. If you have an account in collections or an account that may soon go into delinquency, you may be scrambling for money to pay it off. A personal loan may be an option. In most cases, you’d avoid borrowing to pay off a debt, but sometimes it’s worthwhile, especially if you can get a reasonable interest rate on a personal loan. Delinquent accounts can generate significant penalties and do serious damage to your credit, and if a personal loan allows you to avoid that it may be worth the cost.
- Paying taxes. If you’re facing an unexpected tax bill and you don’t have the cash to pay it, a personal loan could bail you out. It may be worth checking to see if you qualify for an IRS repayment plan, though. The repayment plan might give you a lower interest rate and more favorable terms.
- Paying medical bills. Medical bills can get out of hand fast, and a personal loan can be an option for paying them. Before you borrow to pay medical bills, be sure to exhaust your other options. Consider hiring a medical bill advocate or trying to negotiate a lower cost with the provider. You may be able to negotiate a repayment plan with better terms than you’d get on a loan.
- Home repairs. Home improvements can be expensive, and a personal loan can help cover the cost. Before you borrow, though, ask yourself whether the improvement is something you want or something you need. A leaky roof that’s threatening to do costly damage might be worth borrowing to fix, and you might be better off saving for a kitchen remodel or a new bathroom.
- Weddings or other events. Many people borrow to fund weddings and similar celebrations. Everyone wants a memorable wedding but remember that starting married life with a large debt can place stress on a relationship. Are there other shared financial goals that might be higher priorities? Consider unconventional ideas that might give you a celebration you’ll remember without a debt you can’t forget!
- Paying for a divorce. A divorce is a less happy occasion than a wedding, but it can also be expensive. It’s worth paying for an experienced lawyer, though, as the terms of a divorce can be with you for a long time. A personal loan may also be available to you in your name only at a time when joint accounts are not accessible. You will want to cut costs as much as you can, but a personal loan is a viable option for financing a divorce.
- Major purchases. A personal loan can be an effective way to fund a major purchase, especially if you can get a better interest rate than you’d pay with a credit card or a store installment plan. You’ll still want to evaluate how badly you want or need the item. If you’re replacing a broken refrigerator, borrowing is probably a better option than it would be for buying a new stereo or gaming setup.
- Moving expenses. If you have to make a long-distance move, you may be looking at some significant costs. A personal loan can help but consider the costs and risks of going into debt and weigh them against the benefit you’ll get from moving.
- Starting a business. A personal loan can cover startup costs for a new business. Remember that your credit will suffer if the business fails to generate enough money to pay the loan. You should be prepared to cover the payments if necessary. Consider alternatives such as loans provided by the Small Business Administration.
- Paying for a funeral. Funerals can be expensive, and when they are unexpected the financial stress can be added to the emotional stress of losing a loved one. A personal loan can be a better option than using a credit card, and some lenders package personal loans specifically designed for financing funerals. It’s hard to think about business when you’re grieving, but it’s worth negotiating with the funeral provider to see if you can reduce the amount you’ll end up owing.
- Taking a vacation. We all want to take a dream vacation but going into debt for a holiday is something you’ll want to consider very seriously. If you have an opportunity that may not be repeated it may be worth it, but always evaluate the options carefully and be sure that you’ll be able to make those payments!
Before you decide to borrow money for any of these purposes, you’ll have to look closely at the cost and commitment of a loan and decide whether the purpose justifies the costs and risks of taking on debt.
Making Your Decision: To Borrow or Not?
Taking on debt is not something to do casually. You’ll need to assess your options carefully. Here are some questions to consider.
- Are you borrowing to save money, as in debt consolidation, or as a lower-interest alternative to using a credit card for a necessary major purchase?
- Are you borrowing to earn money, as in funding a business?
- If you are borrowing to spend money, is the expense something you need or something you want? Could you achieve the same goal with a less expensive purchase?
- Could you delay the expense and fund it by saving instead of borrowing?
- Are you confident that you will be able to make the payments in the future, even if unexpected events arise?
- Can you take out a personal loan without pushing your debt-to-income ratio to a dangerous level?
Addressing these questions honestly and thoroughly should help you make a confident decision on whether or not borrowing is justified in your situation.
A personal loan is a versatile financial option that can help you achieve important financial goals. As with any loan, a personal loan can also add financial stress and raise your total debt level, which could affect your ability to get credit in the future and even your ability to pay your debts.
Evaluating your purposes, options, and ability to pay carefully can help you make sure that your personal loan will help you instead of harming you.