When done responsibly, taking out a personal loan is like making an investment in your future. When done irresponsibly, it’s like gambling with fate. So how can you tell the difference between the two?
Fundamentally, a sensible situation for a personal loan will lead to some kind of value beyond the dollar amount. Whether you’re preventing catastrophe, building on success or streamlining a financial process, loans should only be pursued as part of a larger financial plan — not as a knee-jerk reaction to temporary misfortune.
Here are some situations in which taking out a personal loan might be the best option — or the only one.
Pay off credit card debt
The best reason to take out a personal loan is to pay off credit card debt. Consumers with excellent credit scores can qualify for a low interest rate on a personal loan and use that money to pay off high-interest credit card debt.
For example, those with credit scores of 750 or higher can get approved for personal loans with APRs as low as 2.69%. The average credit card rate is currently 15%. If you pay off credit card debt with a personal loan, you could save thousands of dollars on interest.
Paying off credit card debt with personal loans can also help your credit score. That’s because as installment rather than revolving debt, personal loans don’t have a credit limit the way that credit cards do. This affects your credit utilization percentage, which is one of the top factors when determining your credit.
Finding money to launch a new business can be tricky, and personal loans are one way to find the funding you need. Most banks will ask for a business plan or other information, so be prepared to prove your business idea won’t turn into a money pit.
If you’ve already started your business, a personal loan can give you the cash to expand faster than if you tried to raise the money yourself. You can use the increased revenue to pay off the personal loan early or reinvest in the company.
Just remember, in this situation a loan should always be used as a tool to move forward. If you’re using that money to settle overdue bills and pay salaries, you’ll just be digging a deeper hole that might be impossible to climb out of.
Pay off medical bills
The No. 1 reason for personal bankruptcy in the U.S. is medical debt. Even with insurance, many people struggle to pay off expensive surgeries, lab work and tests. If you’re drowning in medical bills and have already negotiated with the hospital, it might be time to seek out a personal loan.
Many hospitals and doctor’s offices offer financing and determine their own interest rate, but you might find lower rates with a personal loan. Some people also take out personal loans to pay for elective procedures not covered by insurance, such as fertility treatments, LASIK and plastic surgery. Physicians may offer payment plans for these procedures, but personal loans might have better deals. Even small differences in interest rates can translate to massive sums when dealing in large amounts, so make sure to shop around before committing to a plan.
Remodel your home
Often, homeowners move into a house not realizing that it needs more upkeep than they predicted. If they don’t have enough equity in the home or are cash-poor from moving, finding the money to renovate can be impossible.
That’s where a personal loan can come in. Every bank has their own maximum personal loan, but most allow users to borrow from $25,000 to $40,000. That’s enough for a new bathroom, finished basement or expanded kitchen.
If done correctly, a home remodel with a personal loan can save you money in the long run. The improvements made to your house can increase your property value and possibly push your equity over the 20% mark. That would allow you to refinance your mortgage and remove private mortgage insurance if you have it, saving you thousands of dollars.
One of the top reasons consumers take out personal loans is to pay off all their other debts to streamline the repayment process. Keeping track of what you owe can be difficult if you’re juggling credit card debt, student loans and car payments. A personal loan allows you to combine those debts into one tidy monthly payment.
Depending on your interest rates, a personal loan might have a lower interest rate than some of your other debts. That interest savings can be used to pay more than your minimum payment, accelerating your debt payoff. You can also use the savings to beef up your emergency fund, start a retirement fund or save for a down payment. Make sure to review the lenders available on SuperMoney to see which offer is right for you. Look at how much you can borrow, the interest rates available and the terms they have.