4 Bad Reasons to Get a Personal Loan, and What to Do Instead
Life is expensive these days. When unexpected costs arise, it can be tempting to consider looking for a loan to make ends meet. Personal loans can be used for a vast array of purposes, from doing home repairs, to consolidating credit cards, to buying a vehicle.
Personal loans are installment loans, which means you get a chunk of money upfront that you pay back, with interest, over a set period of time. These loans usually come with a fixed interest rate, and you make regular monthly payments of the same amount each month until the loan is repaid. Credit cards and lines of credit, by contrast, have no set term or fixed monthly payments beyond a small minimum.
Personal loans are often unsecured, meaning the lender doesn’t require you to put down collateral, such as your house or car, to back up your loan. Instead, the lender looks at your credit score and other information to determine how likely you are to repay it. The better your score, the more likely you are to get a loan and the better your interest rate will be.
When you may not need a personal loan after all
While it’s true that personal loans can fund a variety of things, taking on this kind of debt is not always the wisest choice. The interest rates on personal loans may be higher than those for secured loans, like car loans and mortgages, so they are probably only best for necessary expenses, which you plan to repay quickly. It’s also not usually the best choice to borrow money for unnecessary expenses.
Here are a few things that you may be tempted to finance with a personal loan, but are probably best approached in a different way.
Funding vacations or luxuries
Taking on debt to buy big-ticket “extras” like jewelry and vacations is hardly a savvy financial decision. The cost of such things makes it unlikely you’ll be able to pay the debt back quickly, which means you’ll be paying a large amount of interest over time to purchase something you don’t need.
Consider this alternative instead: Think about cheaper ways to get the feeling of luxury or “treating yourself” that you’re after. What about a relaxing “staycation” or an adventurous camping trip? Perhaps spring for a manicure instead of a necklace. It’s best to limit any shopping sprees to whatever you can afford with the money you have on hand.
Paying for a big event
While landmark events like anniversary parties, weddings, and bar mitzvahs are certainly important, going into debt over them will leave you facing long-term consequences for a one-time celebration. These life events can be commemorated well without lavish trappings; it’s best to think carefully about what you really care about in the situation before opting to fund an expensive party with a loan.
Consider this alternative instead: There are many ways to reduce the cost of parties and events, whether that means making DIY decorations, using a no-cost space like your backyard or reducing the guest list. If you decide to take out a loan to host an event, focus on making the amount as small as possible by only funding the absolute necessities for the event this way.
Financing a car
Using a personal loan to buy a car or other vehicle is rarely the best financial decision since car loans usually come with better rates, are easier to get and have fewer fees than personal loans. Buying a car without financing at all may be the smartest move, but it can be difficult to save enough in the right time frame to be able to do so.
Consider this alternative instead: Try to save up and buy a used car without any loan at all if you can. If it’s not possible, the best way to finance a car is usually with a car loan; you’ll get the loan more easily and end up paying less over time. However, keep in mind that auto loans are secured loans. Fall behind on your payments and you could lose your car.
Starting a business
Small businesses fail at an eye-opening rate— 20% within the first year and 50% by the fifth. This means that starting a business is a risky investment, so it’s best to think carefully about how much debt you take on in order to make it happen. It may be possible to bootstrap your business — starting it without any borrowing — or to find a business-oriented loan that has better rates than a personal loan.
Consider this alternative instead: If there’s any way to start your business without borrowing at all, pursue that route assertively before taking on debt. If you do decide to borrow for your business, look for small business loans with good terms, such as an SBA loan.
When it may make sense to take out a personal loan
There are certainly times in your life when taking out a personal loan may make sense. The best times to use personal loans are when the expense is strictly necessary and you have no other way of getting funding and/or when you’ll be able to pay the loan back quickly. There are a variety of things that are likely to fit such a description:
- Needed home repairs
- Medical bills
- Credit card or other debt consolidation
- Travel to visit an ailing relative
- Hosting a funeral
It’s generally best to treat personal loans as a funding source of last resort, second only to credit cards. Try to find ways to do without a loan, but if you must take on this kind of debt, concentrate on paying it back as quickly as possible.