When to Think Twice About Getting a Personal Loan
Personal loans offer fast cash, but beware the pitfalls of taking on high-interest debt
If you’re buying a home or going to college, you may have no choice but to take on a mortgage or student loan. But personal loans are a horse of a different color. Before you take that ride, ask yourself some key questions.
What is a personal loan?
“A personal loan is a way to obtain cash without requiring the use of collateral. The interest rates are usually higher on a personal loan because you do not necessarily need to secure it with an asset such as a house or a car,” says Anjali Jariwala, a certified financial planner and founder of FIT Advisors in Chicago.
On one hand, personal loans are an attractive option for people who need to fix a cash-flow issue. On the other hand, the interest rates can trap you into debt you might regret.
When is it a good idea to get a personal loan?
Whether or not a personal loan is a smart idea largely comes down to what you're going to use the money for. “My guidelines for when to take a loan out are pretty straightforward,” says Katie Brewer, a certified financial planner and president of Your Richest Life in Garland, Texas. “It makes sense to take a loan out if you're buying something that will either stay the same value or increase.”
Essentially, your personal loan should be used for something that can provide a tangible value in your life or to leverage opportunities that can increase your net worth, like funding your education or home improvements, according to Capital One. So while it may be tempting to use a personal loan to pay for that once-in-a-lifetime vacation or gorgeous new bedroom set, it may not be the best reason to take on debt.
Some other examples of when taking out a personal loan might make sense:
- Consolidating high-interest debt, like credit card debt
- To pay for unforeseen expenses, like medical costs
- To pay for a necessary large expense, when there is a cash-flow issue. Anjali Jariwala adds it’s “OK to take out a personal loan is to cover a short-term cash need or if unavoidable costs come up.”
If you're considering a personal loan to pay off debt, make sure you are treating the source of the problem, like overspending or not sticking to a household budget. Adding debt on top of debt could get you in serious financial trouble and hurt your credit score if you are behind on payments.
Adam Hagerman, a certified financial planner and financial coach says, “If you can reduce your interest rate [by consolidating high-interest debt] and secure a payment that can give you some breathing room in your budget, I'd say go for it. However, before you do it, you need to address the reason you got into debt in the first place. If you don't address your spending issue, you'll now have the personal loan plus credit card debt.”
Hagerman adds, “If you're considering a personal loan for anything else, I'd recommend saving for it through the budgeting process. Map out how much you need and start saving for it. If you don't, you'll be stuck in a never-ending cycle of debt.”