You have needs, wants, desires, and dreams. Much to our chagrin, achieving these aspirations requires money. But what if you don’t have the cash you need? A personal loan is a viable option when you need financial support to accomplish your goals.
What is a personal loan?
Personal loans are sums of money individuals can access and use for various expenses. When using a personal loan, you must repay the borrowed money overtime and in full by a fixed end date. These loans have fixed interest rates and must receive equal monthly payments over the agreed-upon repayment term, usually ranging between one and seven years.
The sum of money you receive from a personal loan depends on factors like your credit score, income, debt-to-income (DTI) ratio, and lender. Individuals can apply for the amount they need, but the lender’s policy will limit the total value. When your loan is approved, the lender deposits the money into your bank account.
Ways to Use Personal Loans
Hence the name, personal loans can address a multitude of personal needs. These loans are sometimes costly due to interest rates, so considering your options is crucial. Generally, personal loans are beneficial for large purchases you can pay off in a reasonable amount of time. Avoid using loans to cover expenses you cannot and will not be able to pay off soon. Popular uses of personal loans include:
Debt consolidation
Debt consolidation is when an individual uses a loan to pay off other loans. At first glance, this may seem like a recipe for more debt, but this is not always true. If you have a high-interest debt, you can pay it off with a lower interest rate loan, lowering your monthly payments. In addition to paying less, having fewer bills reduces the likelihood of missing monthly installments. Debt consolidation often proves beneficial for those consolidating credit card debt.
Medical bills
Medical expenses, both expected and unexpected, can ransack your savings. Instead of stressing about money on top of recovery or a desired procedure, a personal loan can make paying off that balance more manageable.
Wedding expenses
Weddings are not cheap. Surprise, surprise! If you and your partner are trying to stay on budget, consider a personal loan to cover expenses such as the rehearsal dinner, rings, or upfront deposits.
Moving expenses
Moving to a new home is stressful enough without the extra weight of financial strain. Individuals can use personal loans to cover expenses like truck rentals, packing supplies, and the cost of movers so they can focus on creating and settling into their new home.
Veterinary expenses
When pet complications appear out of nowhere, or you need some more time to pay off vet expenses, a personal loan can enable you to get your fur baby the care they need.
Home renovations
You want to live in your dream home, but you don’t want to deplete your savings. A personal loan can cover project fees such as new windows or a fresh coat of paint. You could also consider using a home equity loan or HELOC, which typically has much lower interest rates.
Traveling/Vacation
First, it is highly recommend to save for vacation expenses rather than using a loan. Personal loans can cover food, housing, activities, and transportation on your trip, but you risk overspending or having the trip cost you more in the long run due to interest costs. However, it is an option that is flexible, may open up early booking opportunities, and can build your credit score.
Funeral arrangements
During a highly emotional time, the last thing you want to deal with is financial strain. The passing of a loved one can be jarring in addition to heartbreaking, and a personal loan can help you focus on what matters.
Financing other big expenses
You need a new car, you’re looking to adopt, or you have an emergency expense without an emergency fund; these expenses and more can use a personal loan for assistance.
Exceptions to Personal Loans
While the capabilities of personal loans are vast, limitations may vary depending on your lender, and you should use them wisely. Remember: personal loans are not invitations for a shopping spree or to increase your spending.
Typically, the following expenses have limitations when using a personal loan:
Paying college tuition
In 2008, the Higher Education Opportunity Act limited the ability of lenders to offer educational loans. It is highly dependent on the lender. If the lender is capable, school-related costs like supplies or transportation could receive approval. Additionally, it can be difficult for students to access personal loans due to their income levels and credit scores.
Making a down payment on a home
Mortgage lenders often will not accept personal loans toward a down payment. For example, conventional and FHA loans prohibit using an unsecured personal loan on a down payment. Personal loans increase your debt-to-income (DTI) ratio and could signal to mortgage lenders that you’re not a reliable borrower. Lenders want to avoid late mortgage payments, and debt from personal loans can threaten that.
Business expenses
Lenders may restrict your ability to use a personal loan to pay for business expenses or start a business. Additionally, since it is a personal loan and not a business loan, the credit you’d build from the loan is filed under your name, not your company. That means you’d miss out on building business credit. In this way, a personal loan may not be your best option for business expenses.
In addition to expenses you usually cannot fund with a personal loan, you should avoid using them to make investments or cover regular monthly expenses like insurance, rent, or groceries. While it’s not prohibited, this is not a financially sound solution since this behavior can quickly produce additional debt and high interest expenses. In other words, just because you could use a personal loan does not mean you should. Seek other interest-free options that best fit your circumstances before entering into financial solutions that could lead to an abundance of debt.
Personal loans are expensive, and you must be realistic with your financial abilities and limitations when considering applying for one. Address how soon you’ll be able to repay your loan and if you’d spend more using one than seeking other options like a credit card or personal line of credit. Review the interest rates and compare solutions to find the best option.
Unsecured vs. secured loans
Personal loans can be secured or unsecured, but more often than not, they are unsecured.
A secured loan involves collateral. The borrower ties an asset such as a car, real estate, or machinery to the loan. If the borrower cannot repay the loan, the lender can use that collateral to recover the loss. These loans typically have lower interest rates since there is less risk involved for the lender. They are easier to access than an unsecured loan, but you risk losing your assets.
An unsecured loan does not involve collateral, meaning the determination of the loan approval is heavily dependent on creditworthiness. The lender experiences more risk, so they tend to implement higher interest rates, which is why personal loans aren’t often an affordable solution. The higher your credit score, the higher the likelihood you’ll receive a better rate from your lender. Therefore, consider building your credit before applying for a personal loan to achieve lower interest rates and better terms. Refer to our blog about building credit for guidance in this area.
While we are on the topic of credit, remember that personal loans are an opportunity to build your credit score if you consistently make payments on time.
Repaying your Loan
When you use a personal loan, you are approved to use a specific amount of money. Be careful if you don’t know how much money you need to accomplish your goals. You don’t want to pay back or pay more interest than necessary. Personal loans are unlike other solutions such as a personal line of credit where you only pay back the money you spend. If you do not use all the money you received from your personal loan, you could keep and use the extra cash or use it to pay the next month’s payment, reducing the balance. Communicate with your lender and see if there are prepayment penalties.
Personal Loan Alternatives
There are alternatives if a personal loan is not the right fit for you. Here are two other potential solutions:
Credit Card
Credit cards are a good option for people who want to avoid interest rates. They can benefit individuals who know how much money they need and can pay it back when their statement is due. However, credit cards may hinder your abilities due to credit limits, and their rates are often higher than personal loans. Credit cards are best for everyday spending.
Personal Line of Credit
A personal line of credit allows individuals to take the money they need and pay back lenders only on the amount they use. Consider this solution for projects that are not a one-time expense and require flexibility. Personal lines of credit typically have higher limits than credit cards and higher interest rates than a personal loan. In addition, personal lines of credit have a variable rate, meaning it fluctuates over time.
How to Apply for a Personal Loan
To learn more about personal loans or alternatives, call our office at (856) 542-9241 to speak with a team member. If you are ready to apply for a personal loan and are a member of 1166 FCU, fill out our virtual loan application.
