What are the best uses for a personal loan? Some reasons for borrowing are "better" than others, but spending is a very individual indecision. Learn why some uses for a personal loan might be "better" than others, and that some kinds of personal loans are "better" for certain purposes than others.
Most Common Uses for Personal Loans
Personal loans are gaining in popularity but are not currently the most common way to purchase items on credit. The convenience of credit cards, for instance, is hard to beat. You can use them online and for travel. You can get cash back or rewards. But while credit cards might be a great way to buy things, they can be a terrible way to finance things. That's because they tend to carry high interest rates and low minimum payments make it easy for consumers to carry debt forever.
1. Top personal loan use: debt consolidation
So it won't surprise you to find out that the most popular reason for taking out a personal loan is debt consolidation. Personal loans offer several advantages when being used to consolidate credit card debt.
- Fixed interest rate and payment - most personal loans, unlike most credit cards, come with fixed interest rates and payments. You can budget because you know exactly what your payment will be each month.
- Closed-end financing - credit card debt tends to creep up because it's revolving debt. You can pay it down but run it right back up. Personal loans are installment loans with finite terms ranging from one to 12 years. Their balances go only one way over time - down, until you pay them off completely.
- Utilization reduction - credit utilization, or the percentage of available revolving credit that you're using, comprises 30% of your FICO credit score. And if you're looking at debt consolidation, you've probably maxed out your plastic and your score is taking a hit. Moving that debt to a personal loan, which is an installment debt, drops your utilization to zero and can instantly improve your credit score. But only if you stop carrying credit card balances and work to become debt-free over time.
Just remember that only 15% to 25% of people who consolidate debt successfully control their spending. Be very sure that you won't run up your credit cards again (or get a credit counselor to help you) if you plan a debt consolidation solution.
Best personal loan for debt consolidation
The best personal loan for debt consolidation is the one you can afford. Understand that because credit card companies set low minimum monthly payments (which can keep you in debt forever), paying them off with a personal loan could increase your monthly payment - even with a lower interest rate. So the best personal loan for debt consolidation has a term and interest rate you can afford.
Play around with this personal loan calculator and see how increasing the loan term drops your payment. Remember that if you go for a longer term to create an affordable payment, you can always pay the loan off faster if your income rises or your other expenses fall.
2. Personal loans for unplanned emergencies
Another top use for personal loans is the unplanned financial hit - for instance, a large medical expense, emergency veterinary care, an unexpected tax bill or a critical repair. Personal loans are ideal for these uses because lenders process them very quickly. Unlike home equity financing, personal loans are unsecured. There is no need to examine your home or other asset and assess its value.
Depending on the lender, you may be able to obtain your money in a couple of days to a couple of weeks. And you'll get an underwriting decision very quickly - often within hours.
Best personal loans for unplanned emergencies
With a personal loan in a disaster situation, timing may be your most important consideration. So look for lenders that deliver speed. However, steer clear of personal loans "with no credit check" or lenders than promise "money in minutes." These are actually payday lenders, check advance lenders and auto title lenders. Their interest rates and fees can top 400% and they can be very hard to pay off.
3. Personal loans for large purchases
Another great reason to use a personal loan is for a large purchase. Unless you can pay it off immediately or are getting promotional financing (like 0% for furniture), personal loans make more sense for financing big-ticket items than high-interest store loans. And they are almost always cheaper than using a credit card.
Some large purchases can't generally be made with a credit card - like a tiny home. A personal loan can be the perfect solution.
Want to get rewards or cash back with your credit card? That's fine to do. But before making your purchase, get preapproved for a personal loan. Then buy the item with your credit card and pay off the card with a personal loan. You'll probably be able to protect your credit rating and pay less interest. (Personal loan interest rates typically run almost 7% lower than those of comparable credit cards.)
Best personal loans for large purchases
Personal finance experts almost always say that your loan should not exceed the expected life of the item you buy. So if you expect your furniture to last five years, don't buy it with a ten-year personal loan. In general, you should choose the loan with the lowest interest rate and cost and pick the shortest term you can comfortably afford.
4. Personal loans for weddings and parties
Weddings can be very expensive (approaching $30,000 on average, according to The Knot). And parties, especially traditional huge gatherings, can rival weddings in cost. Add to this the fact that you have to put at least 50% down to reserve your venue and may have to nail down a popular location a year in advance. You can see how people get caught short and need financing to pull off these occasions.
Best personal loans for weddings and parties
The problem with financing a party is that it's a one night or a weekend occasion. Do you really want to spend the first five years of your marriage paying for your wedding? Or putting off homeownership because you had to have a destination graduation party?
The most sensible personal loan for most parties is one that you can pay off before the event occurs or shortly afterward. If your wedding is a year out, try to plan one that you can afford with a one-year personal loan. If you can't, consider a longer engagement and save more money for your wedding to minimize borrowing. Many occasions involve gifts of money - it is often a cultural thing. So why not pay down your personal loan as much as possible during the time you have before the party, and use any monetary gifts that you receive to pay off the balance?
5. Personal loans for travel
Yes, travel is another one of those uses for a personal loan that involve months or years of paying for a few days or weeks of pleasure. But here is why the best travel loan may be a personal loan. You can often get large discounts for booking and paying for travel well in advance. And paying 10% interest to save 50% on your next cruise (the two-for-one fare is a common offer when you book very early) is obviously a good decision if you don't have the cash to just purchase the trip outright.
Best personal loans for travel
The best personal loans for travel must be affordable. If you book your trip a year in advance, try to have it paid off before you go. That means your best personal loan for travel is probably one with a low interest rate and a one-year term. If you can't afford the payments, try choosing a less-expensive trip. Or put it off a year, save some money, and then book in advance when you can get the two-fer but also afford the loan payment.
6. Personal loans for home improvement
The most popular home improvement loans are not personal loans. They are home equity loans, because home improvements tend to have high costs and involve a lot of time. So it's worth it to the homeowner to pay the significant closing costs for home equity loans, jump through the underwriting hoops and endure the wait for approval because home equity interest rates are lower.
However, for those applicants with excellent credit, personal loan interest rates can compete with home equity loan interest rates. And they don't require title insurance, an appraisal and weeks in underwriting. Or put your home on the line if you can't repay them. In addition, not all homeowners have enough home equity to borrow with a mortgage. Most lenders don't allow your total financing (mortgage plus home equity loan) to exceed 80% or 90% of your property value.
Best personal loans for home improvement
The best home improvement personal loan depend on how much you'll be spending and how much time your project will take. If you need a large upfront sum for a contractor to build an addition, that's completely different from requiring smaller amounts as you complete a series of DIY upgrades.
Larger amounts will probably require longer repayment terms to keep things affordable. For smaller jobs, choose the shortest repayment term you can afford. Doing a pay-as-you-go project? Consider a personal line of credit. This allows you to spend only as you need and pay interest only on the amount of credit you use. This kind of personal loan, however, usually comes with variable instead of fixed interest rates.
Best Uses for Personal Loans
So, what are the best and smartest uses for personal loans? Some financial advisers only recommend borrowing to gain an asset - an education, additional property value, an investment or a business, for example. Or to reduce your costs - replacing high-interest debt with a lower-cost loan.
Some lenders may be more or less likely to approve your application based on your reason for borrowing because they deem some reasons "better" than others. But borrowing and spending are highly personal decisions. If something is important and urgent enough, and there is no time to save for it the traditional way, that may be your best use for a personal loan.
Just make sure you can afford it before you borrow.
How to Shop for a Personal Loan
You choose your personal loan according to its use and what's best for you. Then, contact several lenders and see what terms they are willing to offer you. Personal loan offers are easy to compare - interest rates, payments, loan amounts and term lengths are all disclosed, so you can choose the right deal.