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What’s the Purpose of a Loan? Common Reasons to Get a Personal Loan
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If you’re in the market for a personal loan, the purpose of your loan can impact which lenders you can work with and what your rates will be. Finding a lender that aligns with your loan purpose and financial goals can make a big difference in your overall satisfaction with your experience.
So, why should you get a personal loan? They can be used for anything from taking a family vacation to consolidating your other debts. Keep reading to learn some of the most common reasons people get loans, where to find them and how to get one.
How do personal loans work?
Personal loans, which are typically unsecured, are repaid in monthly installments with interest.
Because they are unsecured — meaning you don’t have to put down collateral — most lenders will look at your creditworthiness to determine your eligibility and interest rates.
You should always evaluate the purpose of a loan to determine whether you need to borrow and have the ability to make payments. Defaulting on a personal loan can have critical consequences on your credit score and can make it challenging to get other forms of credit down the road.
How to decide if a personal loan is right for you
Before taking out a personal loan, ask yourself the following questions:
- Why do I need a loan? While it may be tempting to take out a loan to purchase holiday gifts for your family or upgrade your computer, personal loans should only be used for necessary expenses. Ask yourself whether you really need to borrow before applying for a personal loan.
- What is the cost of borrowing money? Add up the total cost of borrowing, including all associated interest rates and fees, before making your decision. Compare different types of loans to ensure you’re getting the lowest possible rate. For example, it’s possible that a home equity loan would be less costly.
- Can I handle more debt? If you’re already struggling to keep up with your expenses and pay down your current debts, a personal loan might make matters worse, unless you’re using it to consolidate existing debts. If you feel like you’re already trapped in debt, consider looking for additional income sources or utilizing government assistance programs instead of borrowing.
- Can I afford the monthly payments? You should always consider your ability to repay your personal loan, which means calculating your monthly payment and factoring it into your budget. Use our personal loan calculator to estimate your monthly payment before committing to a loan.
While a personal loan can be a financial lifeboat in some situations, it’s not always the best choice. It’s important to note that there are also bad reasons to get a personal loan. Carefully consider all your options before signing any loan agreements.
Common reasons to get a personal loan
- Consolidate debt
- Cover emergency expenses
- Home improvement projects
- Finance funeral expenses
- Help cover moving costs
- Make a large purchase
- Cover a major life milestone
- Pay for a vacation
1. Consolidate debt
Consolidating debt is one of the most common reasons to borrow a personal loan. According to a 2022 LendingTree study, debt consolidation was the most popular reason to apply for a personal loan among consumers with excellent credit.
Debt consolidation involves rolling multiple debts into a single personal loan. This approach can make sense if you’re able to secure a low interest rate. If you repay your other debts with the money from a personal loan, you’ll only have one fixed monthly payment and you might be able to save money on interest.
The average APR on a 24-month personal loan was 8.73% in May 2022 — the latest data available from the Federal Reserve — while the average interest rate on all credit card accounts is 15.13%.
A personal loan for debt consolidation could also help you:
- Extend your repayment term
- Lower your monthly payments
- Free up more of your income to cover necessary expenses
2. Cover emergency expenses
While it’s best to build an emergency fund to cover unexpected expenses, an emergency personal loan can help if you’re not yet prepared.
Unfortunately, many Americans are unable to put aside money for an emergency savings account. In 2022, the Consumer Financial Protection Bureau performed a survey on consumers and found the following:
- 24% of consumers have no savings in case of emergency
- 39% of consumers have less than a month of income retained for emergencies
- Only 37% consumers have at least a month of income set aside to cover emergencies
Some reasons for an emergency loan include:
- Job loss or reduced hours
- Auto repairs
- Medical bills
- Help for a friend or family member
3. Home improvement projects
If you have a wish list of home updates, you might consider a personal loan to help cover the home improvement expenses.
Improving your home can help build equity and, unlike home equity loans or home equity lines of credit, you won’t have to put your home up as collateral.
You may want to use a home improvement loan to tackle a big project, like renovating your kitchen, finishing your basement or reflooring your home.
Or, you might have an issue that requires immediate attention, such as a broken heater or air conditioning system, a blocked pipe or a gas leak.
In these scenarios, a personal loan can help you pay for the repairs over time – typically two to five years.
4. Finance funeral expenses
When someone dies without leaving behind sufficient funds for funeral costs, it can put an unexpected financial strain on the surviving family members.
The median cost of a funeral with a viewing and burial was $7,849 in 2021, according to the National Funeral Directors Association. Many consumers won’t have enough saved to cover that cost all at once.
A funeral loan could be an idea if you’re struggling to cover the cost of a funeral. You may even be able to get a funeral loan with bad credit.
5. Help cover moving costs
Another idea on the list of loan purposes: covering moving costs. There are many scenarios in which moving loans may make sense:
- You don’t feel safe in your current environment
- You’re separating from your spouse
- You need more space for a child on the way
A job offer in another location can be another good reason to move, but you should consider carefully whether your new income and cost of living will make it possible to repay your loan.
6. Make a large purchase
You can take out a personal loan to finance a large purchase, but that doesn’t mean you should borrow money to get a new entertainment system, patio set or car. Some large purchases are necessary, such as suddenly needing a new major appliance.
On the other hand, auto loans require collateral, which means you could lose your car if you fall behind on payments. It’s a good idea to compare rates, especially if you’re worried about risk.
7. Cover a major life milestone
Whether you’re getting married, going on a honeymoon or thinking about adoption, a personal loan can put these ventures within reach.
In 2021, the average wedding cost $34,000 (including the engagement ring), according to The Knot’s Real Weddings Study. Since many people don’t have that kind of cash lying around, many lenders offer wedding and honeymoon loans to cover those costs.
Adoption loans are available to parents who are looking to cover the following expenses:
- Home studies
- Attorney fees
- Court fees
- Adoption agency fees
8. Pay for a vacation
While taking a trip somewhere can be exciting, travel can be expensive. Between plane tickets, gas for your vehicle, food, shopping, hotels and activities, a vacation can quickly feel unaffordable.
In California, the average fare for a ticket out of Los Angeles International Airport in early 2022 was $331.70, according to the Bureau of Transportation Statistics. At the Chicago-O’Hare International Airport, it was $333.44.
Vacation loans can ease some of the financial burden of having to pay for a trip upfront and instead divide into monthly payments instead.
Does your loan purpose matter?
Yes! The purpose of a loan matters because lenders use this information to not only determine your interest rates, but also whether you qualify for a loan through that lender.
While some lenders are quite flexible on how you can use a personal loan, many have policies around how you can and can’t use the funds you borrow.
For instance, it’s common for lenders to prohibit personal loan funds to be used to cover college expenses or business costs. Often, you’ll have to speak to a student loan lender or small business lender to borrow funds for those purposes.
The way you can or can’t use a personal loan varies from lender to lender. SoFi loans, for example, cannot be used toward post-secondary education, real estate purchases or investing. On the other hand, Upstart does allow you to use its personal loans for college debt (depending on where you live).
4 reasons to choose a personal loan over another type of debt
Consumers have a wide variety of options when they need credit, including credit cards, secured loans and home equity loans, among many others. While each form of credit has its place, there are some situations when a traditional personal loan is the strongest choice. If you need cash, you might consider a personal loan if:
1. You’re looking for a loan that doesn’t require collateral
One of the benefits of obtaining a personal loan is that they are generally unsecured, which means they aren’t backed by assets like your house or your car.
While secured loans typically come with lower interest rates, there is some risk involved. If you default on a secured loan, you risk losing whatever collateral you used to back the loan. If you fall behind on auto loan payments, for example, you might face repossession of your vehicle
Since financial hardship can strike at any time, you might feel more secure with an unsecured loan.
2. You want a safer alternative to a payday loan
If you have poor credit, you may have considered borrowing a payday loan to cover a purchase. However, payday loans are problematic and should be avoided, even if they can be an easy way to access cash between paychecks.
You could be charged sky-high APRs, up to 400%. Plus, more than 80% of all payday loans are rolled over or extended into another loan within 14 days, according to the Consumer Financial Protection Bureau.
A lower credit score won’t necessarily disqualify you for a personal loan, but you may have to look harder at your loan options. There are a number of lenders who offer personal loans for bad credit and will work with you despite your low score, including:
- Avant (minimum credit score of 600)
- LendingPoint (minimum credit score of 580)
- Peerform (minimum credit score of 600)
Your search would be worth the trouble — a personal loan will almost always have lower rates and fees than a payday loan, plus a longer repayment timeline.
3. High-interest credit cards would dig you deeper into debt
A personal loan may give you the chance to secure a lower interest rate and a more manageable monthly payment than what you owe on your credit cards.
As we noted above, the average interest rate for all credit card accounts is 15.13%, according to the Federal Reserve. But APRs on some card types — including travel rewards cards and airline credit cards — can exceed 24%, according to LendingTree data. And if you fall behind on your payments, the credit card issuer may apply a penalty APR on current and future purchases.
If you have the ability to borrow a personal loan at a lower rate, consider it. In addition to a lower interest rate, you may be able to choose a term and monthly payment that better fits your current budget needs.
4. Consolidating your debt would make repayment easier
If you have debt across several credit cards with crushing interest rates, a personal loan is one way to consolidate that debt. Debt consolidation is the most common personal loan purpose, according to a recent LendingTree study on personal loans.
If you have multiple lines of debt or crushing credit card debt, you may consider borrowing a personal loan and using the cash to pay off your outstanding debts. Instead of making multiple payments each month, you will only have a single monthly payment. Depending on the details of your loan, your monthly payment may end up being lower than your previous monthly bills combined.
Another benefit of obtaining a personal loan: Most have fixed interest rates and payments, so your bills are consistent and predictable, and won’t increase over the life of your loan.
When you should not get a personal loan
Personal loans can be a good solution for many people, but for others, it might not be the right fit or the right timing. Here are a few instances in which you may want to reconsider getting a personal loan.
You can afford to pay with cash.
If you can reasonably afford to save up or shell out for an anticipated or unexpected cost, it may be a good idea to avoid taking out a personal loan. This way, you can avoid paying interest and fees. Taking out loans when you can afford to pay in cash could land you in a lot of unnecessary debt.
Your credit needs some work.
Because most personal loans are unsecured, lenders make their decisions based on your creditworthiness. If you have a low credit score, you may not be eligible for low interest rates and could end up paying a lot more in the long run. Consider improving your credit score first.
You can’t keep up with monthly payments.
Just because you’re eligible for a personal loan, doesn’t mean you can afford it. Defaulting on a loan, even if it’s unsecured, can have a heavy impact on your credit and could put you in dire financial straits.
You can find better alternatives.
Personal loans are not a one-size-fits-all solution to every financial challenge. For instance, if you’re not sure what your budget is going to be, you can seek a personal line of credit from a financial institution you are already in good standing with. Or, you can find a 0% annual percentage rate (APR) credit card to avoid paying interest for a period of time.
How to get a personal loan
Getting a personal loan can be a straightforward process, but the details may differ from lender to lender. Here’s what you can generally expect from the personal loan application process:
Start by exploring your options on LendingTree’s personal loan marketplace. This will allow you to compare important factors, including interest rates, loan lengths, amounts and fees, to help you find a personal loan that will best fit your unique situation.
Next, check to see if you prequalify with the lenders you’re interested in. Many lenders offer soft-credit pulls so you can get an idea of the interest rates they’re willing to give you without impacting your credit score.
Once you choose a lender to move forward with, you’ll have to verify your information. Lenders will want to validate your identity, income and residency. It’s important to have your paperwork (such as a government-issued identification, pay stubs and your mortgage or lease agreement) ready to hand over to streamline the process.
Hard credit check
Before you can officially receive the loan, you’ll have to submit to a hard-credit inquiry. This can temporarily make your credit score go down by a few points, so be sure your credit score is in a strong position. Once you pass the credit check, you’ll have to sign your loan agreement paperwork. The timeline for fund disbursement varies by lender, but in many cases, you’ll receive your funds within a few business days.