Personal loans can be used for almost any reason, but some reasons make more financial sense than others. If you’re using the loan to refinance high-interest debt, this can be a smart financial move. However, we caution borrowers against using a personal loan to pay for non-essential spending, such as a wedding or vacation. When it comes to paying for medical expenses, home improvement projects or business expenses, the decision will depend on your circumstances.
- When It Makes Sense to Use a Personal Loan
- When It’s a Judgment Call
- When You Shouldn’t Use a Personal Loan
- Alternatives to Personal Loans
When It Makes Sense to Use a Personal Loan
Paying off debt or refinancing credit cards: Paying off debt is one of the smartest ways to use a personal loan. Consider the scenario of using a personal loan to pay off credit card debt. The average annual percentage rate (APR) on a credit card is 14%. However, if you have a good credit score, you can get an APR as low as 6% on a personal loan. On $10,000 worth of debt that you pay off over three years, this amounts to over $1,300 saved on interest costs.
Educational or professional development: While student loans may get you a better deal on your educational expenses, they aren’t applicable in all situations. Say, for instance, you want to take a course or boot camp through a program like General Assembly or Dev Bootcamp where traditional student loans aren’t available. In this case, a personal loan can be a good financing option.
When It’s a Judgment Call
Home improvement: Because renovations should increase the value of your home, financing these expenditures can be a savvy move. While personal loans can be used for home improvement, we suggest borrowers consider home equity loans or lines of credit, as they carry lower interest rates than personal loans. One downside to home equity loans is that your house will be used as collateral. If you’re unwilling to put up your home and don’t mind a higher interest rate, a personal loan is a solid back-up.
Business expenses: If you can’t qualify for a small business loan, you can use a personal loan instead. Because a personal loan provider will only consider your personal credit history, you don’t need to meet any business requirements to get money—this makes personal loans accessible to startups or very small businesses. However, you’ll be putting your personal credit on the line if your business cannot repay, and the amount you can borrow with a personal loan is much lower than what you can get with a traditional business loan.
Medical expenses: Many medical providers offer payment plans for different types of procedures. We recommend patients talk to their medical provider first to see what financing options are available. If no options are available, or they are too expensive, a personal loan can be a suitable alternative. Some personal loan providers, like Prosper and LendingClub, even partner with medical providers to offer no-interest loans. If that’s not available at your provider, you can opt for a plain-vanilla personal loan instead.
When You Shouldn’t Use a Personal Loan
Wedding, honeymoon or vacation: We don’t recommend using a personal loan–or any type of financing, for that matter–to pay for these expenses. If you can’t afford to pay for them outright, you need to save up until you can (or reconsider your plans). Think about it this way: do you want to be paying for a vacation or wedding three years later? And in the case of a wedding loan, the loan could even outlast the marriage.
Consumer purchases: Personal loans shouldn’t be used to finance unnecessary expenses, like a television or new clothing. Financing these types of purchases is a slippery slope, because if you’re racking up debt rather than saving for retirement, you could be risking your financial future. Similarly to your wedding or vacation, you should save up until you can pay for these purchases outright.
Buying or refinancing a car: An auto loan will get you a much better deal on a car purchase or refinance than a personal loan. Because these loans are secured by the vehicle, you can typically get a single digit APR. Most personal loans, on the other hand, are unsecured, so they carry higher interest rates. The same advice applies for financing RVs, boats or other types of personal vehicles.
Consider These Alternatives to Personal Loans
Many times, loans designed for a specific purpose offer better interest rates than general purpose loans, such as personal loans. Depending on how you plan to use the loan, we recommend the following options:
- Balance transfer credit card for credit card debt: If you have a good credit score and less than $15,000 in credit card debt to refinance, a balance transfer credit card may be a better option than a personal loan. This is because these cards generally offer an introductory period with 0% APR for anywhere from nine to 24 months, meaning you can pay down your debt without accruing interest.
- Home equity loan or line of credit for home improvement projects: Home equity loans let you borrow against the equity you’ve built up in your house, and they have lower interest rates than personal loans. These loans can be a good option for home improvement projects as you can increase the value of your home. One thing to keep in mind with home equity loans is that your house is used as collateral, so you could lose it if you can’t repay.
- Vehicle loan for vehicle purchase or refinancing: While you can use a personal loan to purchase a car, auto loans have much lower interest rates. For example, the average rate on an auto loan is around 4%, whereas the average rate on a personal loan is around 10%.