Here Are the Best (and Worst) Reasons People Take out Personal Loans
Thousands of years ago, in ancient Babylon, the first loans were recorded in cuneiform writing on sun-baked clay tablets. That’s when, I’ve read, humanity’s first bankers started issuing loans of seed grain. After the harvest, farmers would pay them back with interest.
Fast-forward to today, when people are taking out loans for a million different reasons. They’re borrowing money for fertility treatments, cosmetic surgeries or dream weddings. Your average Joe or Jane might be getting a loan to start a side business, buy a purebred Rottweiler or have their Buick’s transmission repaired.
That’s the appeal of a personal loan: You can use it for whatever you want.
Here’s the catch: Some reasons are financially smarter than others. Here are the best and worst reasons to take out a personal loan.
The Best Reasons to Borrow Money
As useful as personal loans can be — and they are super useful — don’t forget the cold, hard reality: You’re going to have to pay it all back.
You’ll be making fixed monthly payments for a while. That’s why it’s best to get a loan only for financially sound reasons. Here are two we consider good reasons to take out a personal loan:
1. To Pay off Your Credit Cards
Paying off credit card debt is the most common reason people get personal loans, according to a number of lenders who have studied this. It’s also one of the smartest reasons.
“Interest rates for personal loans are generally lower than credit card interest rates,” says Joe Toms, a lending industry veteran and president of the online lender FreedomPlus. “For example, credit cards can carry interest rates of 15% to 25%.”
In contrast, Toms says rates on personal loans could be as low as 4% or less.
In other words, you could save yourself hundreds of dollars on interest payments. Borrow money at a low interest rate, then use that personal loan to pay off the balances on your high-interest credit cards.
This also consolidates all your balances into one monthly payment, which is more convenient.
2. For Home Improvements
Want a new kitchen? Nicer bathroom? Backyard swimming pool? Landscaping? Hot tub? Solar panels?
Is the roof starting to leak?
Here’s an easy and effective way to pay for home improvements: a personal loan with fixed monthly payments for, say, two or three years. You can get a lot of bang for your buck.
It’s better than racking up high-interest credit card debt. It’s also a smart move for people who can’t or don’t want to get a home equity loan or line of credit.
Which home improvements pay off the most when it’s time to sell your house? Think curb appeal. Spend your money on the front of your house, where everyone can see it.
The older you get, the more likely you are to borrow for home improvements. For example, the online firm LendingPoint says that’s the reason behind loans for 34% of people ages 35 to 44 and 42% of people ages 65 and older — compared to just 22% of people ages 25 to 34.
Think Twice Before Borrowing for This
Personal loans are proving to be an attractive financial tool for a growing number of Americans. But they can also be misused.
Think twice before borrowing money for the following purposes:
1. To Pay for a Wedding
The average American wedding costs more than $30,000, according to The Knot. Yikes! So it’s no mystery that many couples take out “wedding loans” — personal loans — to pay for big-ticket items like the venue, bride’s dress, photographer, honeymoon, etc.
Younger folks — Gen Y and millennials — are twice as likely as older ones to use personal loans for weddings, according to data from LendingPoint.
Hey, we like a nice wedding cake as much as anyone. But any financial expert will tell you it’s better to save up for things like this — or cut wedding costs — than to borrow for them. That way you won’t be paying interest for years.
The argument in favor of it: OK, we get it. Maybe it’s too late for you to save enough cash before the wedding. In that case, getting a loan is better than charging the whole thing to your credit cards.
2. To Cover Medical Bills
Americans pay more for health care than nearly any other industrialized country, according to numerous studies.
It can happen to any of us. If you slip and fall, or wake up with some weird and mysterious pain somewhere, you too could end up with unexpected and high medical bills.
Before taking out a loan for this reason, look at your alternatives for paying off medical bills first: Work out a payment plan with your hospital or health care provider. Ask them about financial assistance. Or request assistance from a patient or medical billing advocate.
The argument in favor of it: You might consider a loan if it’s the only way to keep your unpaid medical bills from going to collections. Unpaid medical debts can show up on your credit report and hurt your credit score.
Better than the Alternatives
Remember, a personal loan will almost always give you a better interest rate than a credit card or a short-term payday loan.
That’s the main thing to keep in mind, whether you’re borrowing money for a kitchen remodel, a destination wedding — or for seed grain for the next harvest.
Mike Brassfield ([email protected]) is a senior writer at The Penny Hoarder. He’ll have your money next week, he promises.