Personal loans can be a smart way to borrow -- in the right circumstances. Find out when it’s smart to take a personal loan.
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Are you thinking about borrowing money? One of the options available to you is a personal loan. Personal loans can come from banks, credit unions, or online lenders. They can be less expensive than many other forms of credit, although interest rates and fees vary based on your credit score and the specifics of your loan. And, they can be used for any purpose once you've been approved for funding.
Here are some instances when it may make a lot of sense to consider a personal loan.
1. You want to consolidate or refinance high-interest debt
The interest you pay on a personal loan is usually less than the standard interest rate on most credit cards. It's almost definitely less than the interest rate on payday or car title loans, and it may be lower than the interest rate on medical debt.
If you owe money and you're paying a lot in interest, taking out a personal loan to pay off that debt could make a lot of sense. For example, if you're paying $25 monthly to pay down a $1,000 credit card balance at 15% interest and $125 monthly to repay a $5,000 credit card balance at 18% interest, a personal loan may be a good idea.
If you qualify for a personal loan at 10.49% with a 48-month repayment term, your estimated monthly payment will be about the same -- but you'll pay your debt off 1.13 years sooner than you otherwise would've, and you will save $1,714.62 in interest.
A personal loan in this case would save you a lot of money. If you use a personal loan to pay off multiple existing debts, you also consolidate that debt. Consolidation simplifies your life as you only have to worry about paying one lender and keeping track of one loan instead of many.
2. You need funding to start a business
If you have a good idea for a business, you may need some startup cash to get your company off the ground.
You could look for investors, but may not find them -- and might have to promise a portion of your profits or an ownership stake in the company if you do. Qualifying for a business loan is another possibility, but those can be hard to qualify for if you don't already have an established operation.
A personal loan could provide the funds you need to turn your idea into reality. You should be able to qualify for a personal loan at a reasonable rate if your credit is good and you have enough income to show the lender you'll be able to pay the loan back. You can use the funds from your personal loan for any purpose you want, so it'll be up to you to decide how best to leverage those dollars for your new business.
Of course, before you borrow, make sure you have a detailed business plan and a timeline to achieve profitability so you reduce the chances of borrowing for a business that fails.
3. You're hoping to improve your home
Improving your home can be a good investment that increases its value. It could also be necessary in certain circumstances if your home is structurally unsound or develops problems that put you or the house at risk.
If you can't pay for upgrades or repairs out of pocket, you could fund them with a personal loan. Just be sure to weigh the pros and cons of this option versus taking a home equity loan or a home equity line of credit.
Home equity loans and lines of credit both typically have lower interest rates than personal loans because the house secures the loan. If you've used the proceeds of the loan to make home improvements, interest could be tax deductible. Still, while a home equity loan or line of credit may be a better deal financially, using a personal loan for home upgrades instead can make sense under the right circumstances.
If you can't qualify for a home equity loan or line of credit because you already owe too much on the house, a personal loan may be your only answer. Or, you may want to keep some equity in your home -- rather than borrowing close to what it's worth -- so you don't risk ending up underwater and owing more than you could sell the house for. In these circumstances a personal loan could make it possible for you to borrow for upgrades without taking a risk of getting trapped in your home if property values fall.
4. You have big purchases you'd otherwise put on a credit card at a higher rate
Ideally, you should not borrow money for things you don't absolutely need -- but that's not reality. You may decide you're going to borrow for a vacation, a wedding or engagement ring, or another big purchase.
If you're going to borrow, you may be tempted to just use a credit card. After all, it's easy to swipe your plastic and buy what you want. The problem is, credit card interest is usually going to be very high -- unless you have a card with a special 0% promotional APR on purchases.
If you could get a personal loan instead of using your credit cards, you could reduce the interest you pay on your purchases. While you'd still be making the things you buy more expensive by paying interest, you wouldn't pay quite as much as you would've had you used a card.
Just be sure you understand all the costs associated with the personal loan and do the math to see if it's really a better deal.
Is a personal loan right for you?
Personal loans can be a helpful financial tool for increasing your earning power by starting a business or for reducing what you pay to become debt free. Just be sure you borrow responsibly, and that you find a lender offering you a low rate, minimal or no fees, and a repayment term that works with your timeline.
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