10 Times a Personal Loan May Not Be Your Best Option
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A personal loan is a tool best used strategically to help you build financial health. You may choose to consolidate credit card debt with a personal loan, for instance, if you qualify for a lower interest rate and would benefit from a single, streamlined monthly payment.
Personal loans generally come in amounts between $1,000 and $50,000. Beyond debt consolidation, they can be used for nearly any purpose. But since they’re most often unsecured, meaning they’re not backed by collateral such as your house or car, they’re riskier for lenders to supply — and, in turn, come with potentially high fees and interest rates. That makes it crucial to take extra care when deciding if they’re right for you.
5 things you shouldn’t do with a personal loan
Paying back a personal loan will add a monthly bill to your budget, so you’ll need the financial breathing room to take one out. Avoid using a personal loan in the following financial situations.
1. Refinancing a small amount of debt
You likely won’t be able to get a personal loan for less than $1,000. If you have $800 in credit card debt and you’d like to save money on interest, you’re better off prioritizing paying more than the minimum each month to get rid of it. Consider applying a tax refund or bonus to the balance, negotiating down bills and applying the savings to your debt, or adding to your income.
2. Financing pricey nonessential items
A personal loan may make sense to cover some big-ticket purchases, such as renovations that increase the value of your home. But avoid using a personal loan to buy furniture, a TV, a new bike or other items you want but ultimately don’t need. Instead, set up an automatic transfer to a savings account specifically for your financial goal. Some online savings accounts will let you create sub-accounts or apply nicknames to accounts for specific purposes, which can help track progress and motivate you to keep saving.
3. Paying for online impulse buys
Some lenders have partnered with retailers to offer point-of-sale financing, which gives shoppers the option at checkout to pay for a purchase with fixed monthly payments over time. That may make an item you weren’t planning to buy seem more affordable, and the allure even greater if it means getting a loan in just a few clicks. But you’ll likely pay interest for the privilege, making your haul more expensive.
When you buy discretionary items, such as a new pair of boots, aim to cover them with cash, or pay off credit card purchases in full by the end of the month. Having to rely on point-of-sale financing means you can’t afford the item — and you’ll only add to your debt thanks to interest charges. Saving in advance will save you money in the end.
4. Adding to an unpredictable financial situation
Consolidating existing debt across multiple credit cards with a personal loan can simplify your bills. But steer clear of making new purchases with a personal loan if your income is unpredictable or you’re already overwhelmed by bills. The addition of a personal loan payment could strain your finances further.
Instead, consider nonprofit credit counseling to explore ways to budget and pay off debt effectively. An initial consultation to review your financial situation is free, and you can find local certified credit counselors through the National Foundation for Credit Counseling.
5. Borrowing money without a credit check
Lenders look at credit history when deciding whether to issue personal loans. The better your credit, the lower the interest rate you’ll get. If you have no credit history or poor credit, you may be tempted to look into loans that don’t require a credit check, such as payday loans, car title loans or “no-credit-check” installment loans. But they typically charge excessively high interest rates, which could trap you in debt.
Instead of choosing a no-credit-check lender, contact your local credit union. You’ll need to meet specific membership criteria to join and access financial services. But credit unions are often more likely to work with borrowers new to credit or who have a hard time qualifying for personal loans elsewhere.
5 things you shouldn’t pay for with a personal loan
These big, one-time purchases may make a personal loan seem particularly attractive. But saving up over time or picking a different financing method will generally help you avoid unnecessary interest charges.
Starting a marriage with debt from the wedding means less money to put toward a down payment for a home, future kids’ college funds, or furniture for a new shared space.
An introductory 0% interest credit card is a better way to finance some wedding costs. You’ll likely have a period of 12 months or more to pay them off, interest-free, and you may even get rewards such as cash back. That can add up if you’re paying for large charges, such as the reception venue or photography, with the card.
Taking vacation is essential to your well-being, but using a personal loan to cover it may be a recipe for resentment later. When you take months or even years to pay off one lavish trip, you have less freedom to cover spontaneous adventures in the meantime, let alone other financial goals such as retirement or a new home.
Save up cash throughout the year in a “Fun Money” account. Create flight alerts for your must-see destinations, start searching for airfare far in advance, and stay flexible on the time of year you’re willing to go. Also, explore whether you qualify for a travel rewards credit card, which could help you accrue enough points or miles to get free flights or hotel stays. That’s only wise, though, when you can pay your credit card balance in full each month.
3. Computer upgrade
With so many ways to buy new or used electronics at a discount, skip the personal loan. Shop for refurbished laptops from the manufacturer or other trustworthy retailers. Or wait for Thanksgiving, Black Friday or Cyber Monday, when you can get electronics for especially low prices. You can shop deals online to avoid frenzied crowds.
Plus, many credit cards offer extended warranties on electronics bought with the card. You may want to take advantage of that benefit if you know you can pay off the purchase quickly. Terms may apply.
The average APR on a new-car loan was 6.19% in January 2019, according to research by Edmunds, a website that analyzes trends in the auto industry. Interest rates on personal loans, on the other hand, can reach 36%.
If the car dealership doesn’t offer you a competitive interest rate, or you’re concerned your credit score will lock you out of the best deals, shop around. Credit unions, community banks and online lenders offer financing, and getting preapproved before hitting the dealership will give you more leverage when negotiating the terms of the loan.
Holidays and major events such as graduations put the pressure on to give the perfect gift. While your heart may be big, your budget doesn’t match it if you need to use a personal loan.
Opt for do-it-yourself gifts such as crafts or baked goods, set online price alerts for specific items and take advantage of seasonal sales. You’ll save big if you shop long before the occasion. Setting aside a small amount each month for gifts leading up to the holidays, even if it’s just $10, can help, too.
The bottom line
Planning ahead and shopping around are the biggest antidotes to falling into debt you don’t need. While personal loans are available for many purposes, stick with smarter strategies and you’ll have the room in your budget — and peace of mind — to pursue the financial goals you care most about.