At some point in your life, you may be interested in a personal loan. It can open the door to a variety of possibilities that otherwise wouldn’t be immediately available to you due to a lack of funds, allowing you to make a large purchase like a computer or finally tackle some home improvements. Like most loans, you’re able to pay off a personal loan over time at agreed-upon terms with a lender—typically with fixed interest.
Unlike the typical mortgage or auto loan, personal loans are generally unsecured. Lenders take more of a risk when making unsecured loans because they won’t have assets to recover in the case of default. For example, when a borrower defaults on a secured auto loan, a lender can repossess the vehicle and sell it to help pay off the loan. However, if a borrower defaults on an unsecured loan, there’s no collateral that the lender can recover and sell. As a result, personal loans often carry a higher interest rate than secured loans.
Personal loans aren’t right for all situations, though. Let’s uncover the best-use cases for this type of loan as well as those that aren’t as suitable.
YES, a personal loan may be a good idea for:
- debt consolidation: Because credit cards (especially store cards) may carry higher interest rates, consolidating debt from a credit card to a personal loan may be a smart idea.
- home renovations: Have you always hated that old bathroom? If you don’t have equity built up in your home, taking out a personal loan to fix up a section of your home may increase the value of your house and help you build credit at the same time. (If you do have equity in your home, a home equity loan or line of credit may offer better financing options with lower rates and possible tax advantages.) Just be sure you’re comfortable with the length of time you’re given to repay such a large loan.
- career advancement: Even after you have a college degree in hand, some additional certifications and training can pay endless dividends for your future career prospects in the form of promotions, new jobs and more.
- unexpected expenses: It can happen to anyone at any time. A tree falls through the roof of your house, you have a family emergency or your car is totaled in an accident. You may need a personal loan to help you recover from sudden, expensive inconveniences, and some lenders can provide funds as soon as the next day.
NO, avoid personal loans for:
- extravagant vacations: Always wanted to backpack through Europe or spend the summer in the Caribbean? A personal loan shouldn’t be your way to fund an elaborate vacation if you have trouble paying it back. While a personal loan can be a fine way to finance a honeymoon or an important trip to visit family or friends, be careful not to borrow more than you can afford to pay back.
- weddings/birthdays/graduations: Parties aren’t the best use of personal loans if you spend more than you can afford to pay back. If the loan payments are reasonable for your budget and the event is a top priority for you, then a personal loan may be worth considering, but don’t bury yourself in payments for events that only last a day.
- extra spending money: Whatever the reason, taking out a personal loan to afford a lifestyle your current finances can’t support generally isn’t recommended.
It’s important to recognize that there may be times you think you need a personal loan when cutting your expenses or picking up a part-time job might work just as well. A good thing to remember is that your personal loan should improve your financial standing once it’s paid off.
Navy Federal Credit Union can assist you in weighing the benefits of a personal loan and help explain the options available to you.