Personal loans give you the opportunity to finance just about any purchase, but applying for one isn’t always a wise move. The fact that you qualify for a personal loan (even one with a stellar rate) doesn’t mean you should sign that loan agreement.
Whether you should take out the fastest cash loan will ultimately come down to your situation and financial goals.
If you do have a real need to borrow, be smart about it and find the product that makes sense — it won’t always be a personal loan. Sometimes, it’s better to delay a purchase, save and pay in cash instead of burdening yourself with more debt.
Here are five times you should reconsider taking out a personal loan and turn to other options instead.
- Paying for College Or Refinancing Student Debt
Figuring out how to pay for college isn’t easy. Personal loans are one option, but they shouldn’t be your first choice.
Most students will get a better deal with federal or private student loans than they could with a personal loan. For example:
- Federal student loans don’t require a credit check and offer robust borrower protections.
- Rates on federal and private student loans are usually lower than personal loan rates.
- Student loan interest is tax-deductible, but personal loan interest is not.
Those benefits apply if you’re trying to refinance student debt as well.
There are benefits to using a personal loan to pay off student loans. You can:
- Remove a co-signer from the debt
- Consolidate multiple loans into one payment
- Get a better term or rate
But those benefits aren’t limited to personal loans. You’ll also get them — plus a few more — when you refinance student debt to replace it with a new student loan. Do your parents hold the loan right now? They can also refinance a parent plus loan and receive the same benefits. If it’s time for the loan to be transferred into your name, they can refinance the loan to you and take advantage of lower interest rates. Private student loan refinancing tends to deliver significantly lower rates than personal loans, and you still get that student loan tax deduction.
- Financing A Car
I recently bought a car and opted to finance it with a car loan. It’s the first debt I’ve taken on since paying off my $107,000 student debt.
It helped that I qualified for a great auto loan rate — better than I’m likely to find offered on a personal loan.
Unlike an unsecured loan, an auto loan is a secured debt that’s guaranteed by collateral — typically the car you’re purchasing. If you’re unable to repay the debt, the lender can repossess the car and sell it to recover the money it lent you.
Since auto loans are structured this way, there’s less risk to the lender. And because there’s less risk, auto loans often are easier to qualify for and carry lower interest rates than personal loans. The Federal Reserve Bank’s most recent survey of commercial bank interest rates in the second quarter of 2017 shows just how big the gap can be:
- Average 60-month car loan APR: 4.24%
- Average 24-month personal loan APR: 10.13%
Personal loan rates are 138.92% higher than those offered on auto loans, and the term is less than half. Basically, with a personal loan, you’d have to pay more than twice as much interest and pay off the loan in less than half the time. For car buyers, it’s simply not a good deal.
- Consolidating Smaller Debt
One of the most popular uses for personal loans is consolidating or refinancing debt. A personal loan used to consolidate debt can result in simpler money management and a lower interest rate, which will save you money on interest payments.
However, not everyone will save by consolidating credit cards with a personal loan. Or the savings might be so small that the payoff simply isn’t worth the hassle.
For instance, you might be counting on that low rate the lender advertises. But the rates you qualify for could be significantly higher than the marketed APRs (notice lenders say you can get rates “as low as” these). Consolidating debt with a personal loan also can add origination fees and other costs to your balance.
If you have a smaller credit card balance you could knock out with 12 to 18 months’ worth of concentrated effort, a personal loan might not be your best move. Debt consolidation could be too much hassle for little reward.
Instead of using a personal loan to refinance small-balance debt, consider performing a balance transfer with a zero-interest credit card. You also can up your payments and knock out the balance without moving it to another loan or credit card.
- Paying for A Vacation
Most people are too willing to borrow to finance their getaways, according to a recent survey from financial planning company LearnVest. Three out of four Americans (74%) say they’ve gone into debt to finance a vacation, borrowing $1,108 on average.
Here’s the thing: Vacations are non-necessary purchases you can save and plan for. If you have to take out a personal loan or use a credit card to pay for vacation costs, that’s a red flag that you’re buying something you can’t afford. Even worse, interest charges add to vacation costs. So, by definition, you’re paying more for your trip than it’s worth.
Instead of using a personal loan to pay for a vacation, plan a less expensive trip closer to home that you can pay for in cash. Or delay the expensive vacation and make a plan to save up for it.
- Covering Expected Major Expenses
When you’re facing an emergency or time-sensitive expense, a personal loan can be a cost-effective way to borrow the funds you need.
Personal loans are often used to fund home improvements, for example. Some home repairs, from a leaky roof to a failing furnace, can’t be put off. In those cases, a personal loan can help you fund repairs to maintain a functional home if your on-hand cash won’t cover all the costs.
But there’s a big difference between an unexpected expense and one you simply failed to plan for. Remodeling your kitchen, for example, can wait. Living with an outdated kitchen for a year or two while you save up is worth it to avoid unnecessary debt.
You also might be considering a personal loan to pay for a wedding, a cross-country move, starting a family or another major life event. If you know you want to take these major life steps in the future, that calls for a savings plan — not a personal loan application.
Think Twice Before Taking Out a Personal Loan
If you’re thinking of taking out a personal loan, make sure it will further a financial goal rather than set you back. Calculate your personal loan payments to ensure you can fit them into your budget.
Lastly, if you can wait to make the purchase and save instead of taking out a personal loan, do so. Take a long view of your finances, and you can set today’s money priorities to match your long-term goals. With some proper planning, budgeting, and saving, you can set yourself up for a debt-free future and lasting wealth.
This is a guest post by Alexander Levin, a financial adviser from one of the premier licensed money lender in Singapore.