Ideally, unexpected costs can be covered with an emergency fund, but even a sizable savings account won’t be able to shield you from every financial pitfall life can throw your way. In the right circumstances, a personal loan can offer the chance to get ahead of your financial situation.
With extra capital right now, you can restructure debts, cover urgent expenses or make an investment that will pay off for years to come. “The beauty of the personal loan is that you know exactly when that debt will get paid off and what it’ll cost you,” said Gerri Detweiler, a credit and lending expert.
Here are some reasons why a personal loan can be just the thing to give your finances more breathing room.
1. Tackling Student Loan Debt
More Americans, from recent graduates to those well into their careers, are held back by student loan debt and struggle with higher balances, according to a report from the Federal Reserve Bank of New York. The data showed that student loan delinquencies rose in 2014 even while delinquencies fell for all other categories of debts, including credit cards and mortgage.
But some newer types of personal loans can help borrowers address unwieldy student loans and avoid default and delinquency. Lending startups such as SoFi, CommonBond and Earnest provide student loan refinancing with access to lower interest rates. Some of these options offer average savings of around $14,000, reported Forbes.
“It’s always smart to compare your current loan terms with what else is available,” said Charles Tran, founder of CreditDonkey.com. “If your credit or income situation has improved, then go ahead and compare rates.”
2. Dealing With High Credit Card Balances
“One of the big reasons to consolidate with personal loans is to save money,” Detweiler said. Personal loans allow borrowers to secure a lower rate than they might pay on high-interest credit cards.
A borrower with a good credit score could get rates of 14 percent to 15% percent, said Detweiler, which beat many credit card rates which can typically be 20% APR or more. Borrowers with excellent credit might even be able to find interest rates in the single digits. Plus, a credit card issuer’s rates can change and rise later on. A personal loan, however, offers the chance to secure a loan at today’s low interest rates.
Personal loans can help you pay off credit card debt faster, though that’s due to the trade-off of making higher monthly payments. “With shorter-term debt like a personal loan, monthly payments will be higher than what you might put toward a credit card, so you need to make sure you’re making room in your budget for that payment each month,” Detweiler said.
3. Boosting Bad Credit
A personal loan can be a way to bolster credit reports and even raise scores. For instance, Lending Club reported that 77 percent of its borrowers had an increase in their FICO scores just three months after taking out a personal loan.
“Credit scoring takes into account mix of credit accounts,” Detweiler said. If you only have revolving accounts like credit cards on your report, opening an installment account like a personal loan could give your score a boost.
Personal loans are even better when used to pay off credit card debt. “Getting credit card balances down will get utilization ratio down,” Detweiler said, which measures the portion of available credit you have borrowed. “If you use a personal loan to pay down balances without closing credit cards, you would lower the ratio and could see your credit score improve.”
4. Covering Emergency Medical Bills
Even with health insurance, plans with high deductibles and out-of-pocket limits can still leave American families on the hook for thousands in medical bills. The Federal Reserve Board’s Survey of Consumer Finances found that less than half of households — about 48 percent — had enough liquid assets to meet even low out-of-pocket limits.
For households like this, a health scare can quickly turn into a major financial hardship with medical bills they can’t pay. When this happens, the first step is to “see if the medical provider will negotiate,” Tran said. “They [would] rather get paid something than nothing.”
Call your provider and try to talk down the amount you owe and ask about payment plans. Even with a payment plan, however, there aren’t guarantees. “The longer that payment stretches out, the greater chance that it will be turned over to a collections agency … which is very damaging to your credit,” Detweiler said. For medical bills that are larger or would take longer to repay, a personal loan can provide a solution to get your costs settled without the risk of damage to your credit.
5. Paying for Urgent Car Repairs
Going without a reliable vehicle is a huge headache that can present even bigger financial setbacks, like putting your employment at risk. Yet most Americans — 62 percent — have less than $1,000 in savings, according to a recent GOBankingRates survey. And that’s not enough to cover a major auto repair on short notice.
Before reaching for a credit card, however, people without the savings to cover a car repair should make sure they’ve considered other options. With credit card debt, it’s too easy to let payments drag out and costs add up. “If you pay only the minimum, you could be paying off that balance long after that car is gone and no longer sitting in the driveway,” Detweiler said. A personal loan provides a definite payment plan that can be a smarter option.
6. Avoiding a Home Equity Loan
For homeowners, home equity loans or lines of credit can seem like the natural choice for financing home repairs or remodels. After all, these loans use the value their homes have accrued to help fund home improvements.
But these forms of credit needlessly put homes at risk. “Home equity loans are scary,” Tran said. “You are putting the roof over your head on the line. A[n] unsecured personal loan allows you to borrow money without putting your house or car at direct risk of foreclosure or repossession.”
7. Funding a Side Hustle
“Starting up a business is a popular use of personal loans,” said Detweiler. If you’re trying to get a side business going, this might require some capital to cover startup costs.
Getting funding often calls for a personal loan. “Young and new businesses have a hard time getting a business loan, so in the initial stages, they often rely on their personal credit,” Detweiler said. As an investment, this personal loan can be a smart move with the potential to pay off by earning a second income.
“Do as much as you can without going into debt,” Detweiler said. “Test the waters and make sure there’s a demand for what you’re offering.” Detweiler added that keeping your day job as long as possible will help you both qualify for a personal loan and provide a steady income so that you can keep up with payments.
8. Investing in Yourself
“[S]ome folks use personal loans to invest in themselves,” Tran said. “For instance, they might use the personal loan to … pay for training.” For some workers, a certification, training or other form of education can be a chance to greatly increase their earning power, but the initial costs can hold them back.
A personal loan can be an affordable way to finance such investments and give the borrower’s career a leg up. If you’re considering this use of a personal loan, do your homework to make sure you’ll get a good return for your investment. “Of course there’s risk involved, but sometimes you have to take that leap of faith,” Tran said.
9. Financing a Major Life Event
Major life events are often expensive, but can’t always be planned for. The less-predictable events can include a big move, a divorce or a sudden death in the family.
Whatever the life event, you’ll need to find a way to pay for it. Savings are a good start, but you might be facing higher costs than your bank accounts can cover. In these cases, a personal loan can help you get the funds you need while also securing a payment plan and interest you can afford.
Know When to Get a Personal Loan
Personal loans can be a smart move, but only as smart as you are when securing one. You should always make sure you’re applying for a loan from a reputable lender — watch out for signs of a scam like promises of loans regardless of credit or lenders that ask for money up front, Detweiler said.
Also, make sure you’re considering all other options. While in the cases listed above a personal loan is worth considering, debt — including a personal loan — isn’t the answer to every money problem. “Anytime you buy something on credit, you pay more for it, and most of us would rather get a discount than pay a premium,” Detweiler said.