When Are Personal Loans a Good Idea?

Personal loans can be a viable option in a variety of circumstances. First, let’s define a personal loan. Some loans are earmarked for a specific purchase. You buy a home with a mortgage loan, you purchase a car with an auto loan and you pay for college with a student loan.

But a personal loan can be used for just about anything. Some lenders want to know what you will do with the money they lend you, but as long as you’ve borrowed it for a responsible and legal reason, you can do what you want with it.

But what does that mean for you? With a mortgage, your home is the collateral. Similarly, with an auto loan, the car you buy is the collateral. Because a personal loan often has no collateral – it is “unsecured” – the interest rate will probably be higher. There are also secured personal loans if you want to lower your costs.

Here are five circumstances in which a personal loan might be a good idea.

1. Consolidate Credit Cards

If you have one or more credit cards that are charged to the max, you could get a personal loan to consolidate all the charges into one monthly payment. What makes this scenario even more appealing: The interest rate on the loan could be considerably lower than the annual percentage rates (APRs) on your credit cards. (See Debt Consolidation Made Easy for more details.)

2. Refinance Student Loans

Refinancing student loans can provide some financial relief. Your student loan interest rate may be 6.8% or higher, depending on the type of loan you have. But you might be able to get a personal loan with a lower interest rate that allows you to pay off your loan(s) faster.

Here are the issues: Student loans come with tax advantages. Also, if lawmakers were to offer any loan forgiveness programs in the future, in addition to those in place now, your refinanced student loans would not be eligible.

If you use a personal loan to pay off all or a portion of a student loan, you will lose the ability to deduct your interest payments (when you file your income taxes) along with the benefits that come with some loans, such as forbearance and deferment. And if your balance is sizable, a personal loan probably won’t cover it anyway. For additional information, check out Student Loan Debt: Is Consolidation the Answer?

3. Finance a Purchase

Financing a purchse depends on if it is a want or a need. If you’re going to take out a loan anyway, getting a personal loan and paying the seller in cash might be a better deal than financing through the seller. Don’t ever make a decision about financing on the spot, though. Ask the seller for an offer and compare it to what you could get through a personal loan. Then you can decide which is the right choice. For one example, see Personal Loans vs. Car Loans: How They Differ.

4. Pay for a Wedding

Any large event – such as a wedding – qualifies, if you would end up putting all associated charges on your credit card without being able to pay them off within a month. A personal loan for a large expense like this might save you a considerable amount on interest charges, provided it has a lower rate than your credit card.

5. Improve Your Credit

A personal loan might help your credit score in two ways. First, if your credit report shows mostly credit card debt, a personal loan might help your “account mix.” Having different types of loans is often favorable to your score.

Second, it may lower your credit utilization ratio – the amount of total credit you’re using compared to your credit limit. The lower the amount of your total credit you use, the better your score. Having a personal loan increases the total amount you have available to use. For other advice on boosting your credit score, see 3 Easy Ways to Improve Your Credit Score.

The Bottom Line

Personal loans can be useful, given the right circumstances. For example, most people can’t afford to pay cash for a home, making a mortgage loan a necessity. Be sure to consult with a trustworthy financial institution and weigh your options.