With more than more than half of Americans reporting less than $1,000 in savings, you aren’t alone if you’re short on cash and considering a personal loan to pay for a range of expenses. For example, you might need a cash infusion to pay off old debts, cover emergency medical expenses, pay for a new roof or other home repairs, paying for your dream wedding or vacation, or even a new 4K TV. Because personal loan rates are typically lower than credit card rates, it can be tempting to apply for a personal loan to meet those needs; however, before you start looking up how to get a personal loan, consider whether your purpose justifies borrowing money.
Types of Personal Loans
Most personal loans are unsecured, meaning that the lender doesn’t require you to use specific assets as collateral. But sometimes you can get a lower interest rate on a personal loan with collateral. If you’re considering using collateral, where to get a personal loan depends on what type of collateral you want to use. For example, banks might use a savings account or certificate of deposit as collateral, whereas others might use a car or house.
Good Uses for Personal Loans
You can use the funds from your personal loan for any purpose. Unlike a mortgage, car loan, or student loan, you’re not restricted to spending the money on one specific purchase or expense. But that doesn’t mean all personal loan purposes are created equal.
Here are examples of good uses for personal loans:
- Personal loan consolidation: Debt consolidation is one of the better uses for a personal loan when you’re combining your debts into one loan with a lower interest rate. For example, if you’re paying 24 percent on one $6,000 credit card balance and 19 percent on a different card’s $10,000 balance, you can get debt consolidation help and save money by refinancing to a personal loan that charges 12 percent interest. If you choose to use a personal loan for debt consolidation, address how you accumulated debt in the first place so you can get — and stay — out of debt.
- Emergency expenses: If you don’t have a large enough emergency fund and a true emergency arises, a personal loan can help bridge the financial gap at a lower interest rate than alternatives like payday loans or loans from a service provider, like a hospital or a car body shop. You might be able to get a lower interest rate with a secured loan like a home equity loan or line of credit, but a personal loan doesn’t use your home as collateral. Ideally, building an emergency fund will mitigate the need for this, but you can’t prepare for every emergency.
- Home improvements: If you’re making improvements that will increase the value of your home, borrowing money can be justified. Plus, a personal loan will save you money on interest compared with what you’d pay if you put the improvements on your credit card. If you use a second mortgage to take advantage of lower interest rates, you might be able to deduct a portion of the interest, but you’ll be using your home as collateral in the event you default.
Bad Uses for Personal Loans
Personal loans can help you get out of or avoid financial trouble. But if you use personal loans for the wrong reason, borrowing money might just make your financial hardship even worse.
Avoid using a personal loan for reasons including the following:
- Splurges: Splurges shouldn’t be financed by borrowing, including using a personal loan. Even if you can get no-credit-check loans, it doesn’t mean you should spend beyond your means. For example, when planning your wedding, it might be tempting to blow your budget and pay for extras with a personal loan. Although using a personal loan is better than carrying debt on your credit card, it’s better to find ways to save money to keep your wedding costs within your current means than spend borrowed money on non-essentials. Similarly, if you want to upgrade the furnishings in your home or take a dream vacation, you’re better off saving until you can pay for the items up front. Whether you want a new TV, new couch, or a trip to Europe, remember that the debt remains long after the experience is over.
- Car loans: Using a personal loan to purchase or refinance a car will usually cause you to pay more in interest over the life of the loan because you can obtain lower interest rates with other loan products. Even if you get a personal loan online, the rates on a car-specific loan will usually be lower because you are using the car as collateral.
- Medical expenses: Medical expenses can sneak up on you without warning, leaving you unable to pay your bill. Before applying for a personal loan to cover medical bills, you should first contact your medical provider to see if you can work out a payment plan with a lower interest rate and better repayment terms than your personal loan offers.
Personal Loan Considerations
Should you decide to take out a personal loan, shop around to get the best deal. Consider whether the personal loan is secured or unsecured, as well as the following factors:
- Interest rates: Interest rates are additional payments — on top of the amount borrowed — that you owe the lender for the privilege of borrowing. A personal loan with a lower interest rate and a shorter term will help keep down your total repayment amount. If you choose to take out a personal loan, choose a lender offering the lowest interest rate. The better your credit score, the lower your personal loan interest rates will be.
- Disbursement of proceeds: Personal loans can give you the entire amount of the loan up front or disburse the funds to you on an as-needed basis — as in a personal line of credit. If you need all of the funds immediately, a personal loan might be the way to go. But if you only need to tap into the funds from time to time, using a line of credit can save you money because you only pay interest on the portion of the line of credit that you have borrowed against instead of the entire amount.
- Fees: Some lenders offer no-fee loans, which means there’s no origination or other borrowing fees. The only liability you’ll encounter is the repayment of the sum borrowed and the interest payments. Watch out for personal loan companies that charge high fees.
- Terms: Different personal loans have different repayment periods. In general, it’s preferable to take out a shorter-term personal loan than a longer-term loan. With a shorter-term loan, you’ll end up paying less in total interest charges.
- Lender: Vet the lender for your personal loan. Understand the loan fees and credit score required by the specific lender. Read reviews to ensure that you’re choosing a reputable firm.
Michael Keenan contributed to the reporting for this article.