Holly Johnson* says there are savvy ways to use a personal loan in preference to a credit card, but it’s important to remember the same pitfalls apply.
Photo: sureeporn
Credit cards make it easy to borrow money in a pinch, but they aren’t ideal when you need time to pay the money back.
The average credit card interest rate is currently between 10 and 15 per cent annual percentage rate (APR), after all.
That’s a tonne of money in interest to fork over for no real benefit, and the cost can be even more crushing if you need months or years to repay.
For that reason — and really, for plenty of others — many consumers turn to personal loans for their borrowing needs.
Unlike credit cards with variable interest rates, personal loans come with a fixed interest rate that can be as low as 4.99 per cent APR.
Personal loans also come with a fixed repayment timeline and a fixed monthly payment that will never catch you by surprise.
If you need to borrow a large sum of money and pay it back over 24, 48, 60 months, or longer, a personal loan can make the experience a lot less expensive and much more predictable.
How you should (and shouldn’t) use a personal loan
Personal loans come with many of the same pitfalls as credit cards, including how you can easily bite off more than you can chew.
You can overspend and send your finances into a tailspin with credit cards or a personal loan if you don’t know your limits.
Really, there are savvy ways to use a personal loan and disastrous ways that can leave you worse off in the end.
Here are some ways to use a personal loan, and some to avoid at all costs.
Smart ways to use a personal loan
If you’re going to apply for a personal loan, make sure you use it the correct way.
Consolidating high-interest debt
If you have high-interest debt that’s making it difficult to get ahead, consolidating with a personal loan can make a lot of sense.
Imagine your credit cards have the average APR of 17 per cent or higher and you’re able to consolidate with a personal loan that boasts an APR of 5 per cent or 6 per cent.
Not only will you save big money on interest payments, but you can simplify your life by going from multiple payments each month down to just one.
Updating your home
A mid-range bathroom remodel can cost from $15,000 to $30,000 while a mid-range kitchen overhaul costs an average of $42,000.
A personal loan lets you borrow a large lump sum of money for a home remodelling project and repay it slowly over time with a competitive APR.
Paying for pricey home repairs
Replacing a leaky roof is expensive, but how would you come up with that money if you had to?
Of course, there are other expensive components of a home that need to be replaced or fixed from time to time, including airconditioning or heating systems, plumbing, electrical, and more.
An unsecured personal loan could provide you with the cash you need with a monthly payment you’d probably be able to afford.
Fixing your car
If the car you drive to work breaks down and needs thousands of dollars in repairs, a personal loan could help you finance the job so you can get back on the road.
Disastrous ways to use a personal loan
Don’t apply for a personal loan if you plan on using it the following ways.
Paying for a vacation you can’t really afford
If you need to borrow money to go on vacation, you’re can’t afford to take one.
That’s a painful truth, but it’s one many people refuse to acknowledge.
Paying for a vacation with a personal loan may seem like a good idea, but you’ll regret it once you’re making payments on that trip for years to come.
Covering university tuition
Going to university is a smart way to invest in yourself, but you should use federal student loans before you use a personal loan.
Not only do federal student loans come with affordable interest rates, but they grant you access to government benefits and protections including deferment, forbearance, and income-driven repayment plans.
Buying a car
Buying a car with a personal loan isn’t the world’s worst idea, but it’s certainly not the best.
An auto loan that is secured by the car you’re buying will likely come with a lower interest rate and better terms.
Gambling
Using personal loan money to gamble is never a good idea.
If you lose your shirt (which you likely will!), you will still have to make payments on your personal loan until it’s paid off.
Never gamble unless you have the money to lose.
Investing
Gambling your personal loan funds is a bad idea, but so is using them to invest.
You may believe you can earn more money investing than you pay in interest on your personal loan, but there are no guarantees when you invest your money — no matter how experienced you are.
If you invest and take a big loss, you’ll be out your personal loan funds plus interest.
Should you get a personal loan?
Personal loans are easy to apply for, which makes them incredibly appealing but also dangerous.
If you borrow for the wrong reasons and don’t have a plan to pay the money back, you could wind up making a financial decision you’ll live to regret.
As a general rule of thumb, it only makes sense to borrow money when you have a clear purpose and a realistic plan to pay it back.
If you borrow without any real goal in mind or the money to repay what you owe, you’re setting yourself up for failure.
* Holly Johnson is a writer and financial expert. She blogs at ClubThrifty.com. She tweets at @ClubThrifty.
This article first appeared at www.wisebread.com/.
