Have you ever experienced a time in your life where you paid your bills, bought your basic living necessities, put gasoline or diesel in your vehicle, then you were out of money until next payday? In moments like these, it may seem like the best thing to do is borrow money to help you make it until you get paid again. The problem is, when the next payday comes, you will have new bills coming due plus a loan to pay back and you may end up broke again. The vicious cycle will likely continue until you have a windfall of cash that can help you dig out of the hole or you find ways to eliminate unnecessary expenses so you can save money. Let’s talk about “When Personal Loans Make Sense.”
There are two types of personal loans – secured and unsecured.
Secured loans are backed by collateral such as a paid off vehicle or a certificate of deposit. If you are unable to make your payments, the lender/financial institution has the right to claim the asset that you used as collateral. This is why it is so important for you to be able to afford the monthly loan payments. Your lender/financial institution never wants to claim the collateral from you, they would much prefer you make the monthly payment.
Unsecured loans are not backed by collateral. Your financial institution will decide if you qualify for the loan based on your past credit history. Generally, the interest rate on an unsecured loan will be higher than a secured loan because there is greater risk involved (no collateral associated with the loan). Therefore, your interest rate and payment on an unsecured loan will typically be higher. Think of it like the “good ole’ days” where a handshake and promise to repay a debt, based on a person’s word, was all that was required. That is basically the same concept as an unsecured loan.
Borrowing money isn’t necessarily a bad thing. As a matter of fact, there are times when taking out a personal loan can be beneficial. Here are some examples:
- Pay off Debt– Getting a loan to pay off debts that have a higher interest rate can be a good technique to save money. If you can get a better interest rate on a personal loan and can afford the monthly payment (one that is lower) then it makes sense to do it. Anytime you can save money on interest, and have a set date to pay off a debt, can be beneficial to your monthly budget. The key to success is being disciplined to stick to the path of paying off debt and not adding new debt. That means living on a spending plan.
- Save Money – Taking out a personal loan, instead of using a credit card, could save you money in the long run if the interest rate on the personal loan is lower. Did you know that the average credit card APR is currently 16.41% according to CreditCards.com weekly credit card rate report? The lower the interest rate is on the personal loan, the less you will pay back. This will help you save on your monthly expenses.
- Improve Credit - Taking out a personal loan establishes credit and can constitute something as relatively simple as applying for a secured personal loan or secured credit card. The longer a person uses their credit card without having a large outstanding balance, the stronger their credit becomes. Also, the longer you have a history of making on-time payments in-full each month, the better your credit will become. Good credit leads to qualifying for lower interest rates when it comes to something like a mortgage or auto loan.
When is it an unwise decision to take out a personal loan? Here are a couple of examples of when it would be best to forego taking on more debt:
- Wedding/Vacation – While a once in a lifetime vacation or hosting the perfect wedding can provide a once in a lifetime experience with some wonderful memories, it is just that, a memory. The experience will be over in a flash, but the debt will be with you for a while afterwards. Taking on debt simply to pay for a vacation or wedding can impact your future financial situation. In most cases, it just not worth the risk and it is better to save up for vacations and weddings or downsize the cost of the experience.
- Payday Loans - These very short-term loans are designed to be paid back on your next pay day. They may seem to offer a reasonable interest rate, but when the APR is calculated with all the fees incurred, the rates can be 400% or more! These are extremely expensive and can add up to really hurt a borrower’s budget and credit.
Personal loans can be helpful, given the right circumstances. Be sure to check your monthly budget, ask yourself if you are borrowing the money to acquire a want or a true need, shop around for the best value, and forecast if you have the job stability necessary to afford the monthly payment for the entire length of the loan. This will help set you up for success to borrow wisely.