Personal Loans: 3 Ways To Use Them And Two Ways Not To Use Them

Posted on August 1, 2017
Personal Loans

Like most people, you probably don’t relish the idea of carrying debt. However, also like most people, you’ll likely run into a situation where you need a quick infusion of cash to solve an otherwise insurmountable problem.

That’s where a personal loan can come in very handy. Used wisely, personal loans can help get you out of a tight spot. Used unwisely, though, a personal loan can trigger a cascade of financial difficulties.

Here are some excellent reasons for getting a personal loan, along with a few that aren’t so great.

Three Excellent Ways to Use Personal Loans

1. Reducing Overall Payments and Consolidating Debt

Credit cards often carry high interest rates that can really inhibit your ability to get your balances under control. This is especially true if you’ve allowed the balances to rise over a period of time by only making the minimum payment or even missing payments, allowing fees and possibly a higher interest rate to be imposed on your account.

Personal loans typically have much lower interest rates than those offered by credit cards, making them a perfect option for paying off high-interest balances. This is known as “consolidating” your debt, or getting it all under a single umbrella so that those multiple small payments are replaced by a single payment on your personal loan.

This plan of action can get your debt under control and make it easier to pay down, but it only works if you stop incurring charges on the cards you pay off with the personal loan. If you keep spending, you’ll soon have your personal loan payment plus all those high-interest credit card payments, too.

2. Financing a Necessary Large Purchase

There are moments in life when you realize that it’s going to be a very expensive week. Perhaps the refrigerator finally conked out (right after you bought groceries), the washing machine sprang a leak and left you with three inches of standing water or that funny noise the car was making finally stopped – because the car won’t start anymore.

Whatever the reason, there are weeks that can pose a giant challenge to your budgeting skills and leave your wallet in tatters. Large expenses often pop up suddenly, promptly draining your savings, your checking account, and everything in the piggy bank, too.

That’s an excellent time to look into getting a personal loan.

An emergency expense has to be covered one way or another. Yes, you could tap into your retirement account, but that might entail tax penalties and other charges, draining your account far more than just the withdrawn amount.

Credit cards are also an option, but their high interest rates mean you’ll be paying more for using that money than you would with a personal loan.

Making smart decisions about paying emergency expenses can save you hundreds of dollars or more in interest and fees over time.

3. Boosting Your Credit Score

Your credit score is based on a number of factors, one of which is your “account mix.” This is an evaluation of the different types of credit in your current credit situation and in your credit history.

There are several different types of credit, but revolving accounts and installment accounts are the most common. Revolving accounts include credit cards and similar types of credit, while installment accounts include student loans, mortgages, automobile loans, and personal loans.

People who have not made a major financed purchase like a home or car may not have installment loans in their credit mix; a personal loan can help build a more diverse account mix, possibly increasing your credit score.

Another way personal loans can help build your credit is by reducing what is known as your “debt usage ratio.” This is a figure representing how much credit is available to you, versus how much of that credit is currently in use.

If you have a credit card with a $1,000 limit and there is a current balance of $500, your debt usage ratio is quite high, at 50%. The higher your debt usage ratio, the more it can impact your credit.

Through the reduction of your debt usage ratio, your credit score could increase, especially since installment loans aren’t figured as part of the ratio.

Two Not-So-Great Ways to Use Personal Loans

1. Supplementing Monthly Spending

Personal loans should never be used to increase your monthly spending money or to meet regular monthly obligations like car insurance, rent, phone payments or other monthly bills.

Personal loans must be repaid, and you’re committing to make your monthly payments on time. That can be tough to do if the payment doesn’t fit into your budget or your monthly spending is already as great as it can be due to your income.

Make sure you know how much money you’re spending every month by making a budget and sticking to it.

Even small expenditures can add up quickly (remember that $4 cup of coffee yesterday…and the day before?), and having a little extra money in your pocket can be a big temptation to treat yourself “just this once.”

Personal loans can be an excellent tool for getting past unexpected expenses, but they shouldn’t be considered a remedy for chronic overspending.

The only remedy for that is to cut your spending to a manageable level, and don’t forget you should be putting at least a little something in savings every month, too.

2. Financing a Big Party

Another bad way to use a personal loan is to spend it frivolously. Yes, your birthday is a big deal, but that’s no reason to go overboard and put yourself into debt just to have a party. The same goes for weddings, graduations, engagements, holidays, and just about every other celebration on the calendar.

Throw the party you can afford, and save the loans for really important things, like car repairs to keep you moving when your life requires transportation. A personal loan isn’t free money, and if you use personal loans when you don’t absolutely have to, you might find yourself unable to get one when you really do need it.

More Things to Remember about Personal Loans

Be Prepared When Applying

Getting a personal loan can be a complicated process, so it’s always best to be prepared before you apply. Many loans work on a collateral basis, such as mortgages or car loans. These are secured by the property purchased with the loan.

If you don’t make your payments, the lender can repossess (in the case of a mortgage, foreclose) the property to make themselves whole on the loan.

With personal loans, this is not an option, so you’ll have to be prepared to prove your creditworthiness or the likelihood that you’ll pay back the loan.

The first thing you might consider doing before you apply for a loan is to get a copy of your credit report and make sure the information in it is correct. Your credit report is going to be a critical factor in getting a personal loan. Inaccuracies can mean the difference between getting a loan and being denied.

Personal loans are generally not secured, or based on having collateral to cover the loan. This means that you won’t need to have something of similar value to be held in surety by the lender to ensure that you repay the loan.

Therefore, having a correct credit report and keeping your credit history in good condition is essential for being able to use financial tools like personal loans.

You’re in Charge of How You Use a Personal Loan

Many first-time borrowers want to know if they can use personal loans for anything, and the answer to that question is that you can absolutely use a personal loan for anything you want.

However, it’s important to remember that there are good ways and bad ways to use personal loans. As part of your process of deciding to get a loan, you should take the time to really understand your reasons.

This is an important time to be completely honest with yourself, because you’re committing your future income to making the loan payments.

It’s your loan, and you can use it for whatever reason you want, from a speckled pup to a sparkling diamond, but it still has to be paid back to the lender.

Make sure your purchase is worth the amount you’re spending, and don’t forget to include the interest. Just because you can get a loan, doesn’t mean you should take one. Know exactly why you’re getting the loan, and have a plan for paying it back.

Keep Your Spending Under Control

Many people live their lives for the here and now, often forgetting that there will come a day when having something in savings could save them a lot of hassle and worry.

Keeping your spending under control, especially when you’ve gotten a personal loan, is essential to your financial well-being down the road. Your income isn’t likely to change if your job and company are stable. However, it’s in your interest to always save like you could lose your job next week. Keep some money in the bank for exactly that purpose.

Financial planning experts recommend that your savings account have at least three months or more of regular monthly expenses as an emergency fund.

Having this kind of cushion can help you avoid financial catastrophes that can happen in the blink of an eye. If you can take care of unexpected expenses as they happen, a personal loan becomes a safety net that you can turn to in extreme situations.

Mind Your Financial Future

Personal loans can be one tool in your kit for keeping your financial future in check. Many borrowers aren’t thinking of getting ahead when they take out a loan, but they should be.

Having the extra infusion of cash provided by a personal loan can be exhilarating, but that only makes it easier to make mistakes with your spending.

Just because there’s a little extra in your bank account doesn’t mean you should run out and spend it as quickly as possible. Treat that money like what it is: borrowed security. You’ve borrowed a bit of security now in return for paying the bank for letting you use it.

In the event that your personal loan is for an amount exceeding the expense you needed to cover, keep that money in the bank against another rainy day.

Never forget that when you’re dealing with borrowed money, it’s not really your money. It’s the lender’s money, and how you choose to handle it can make a big impact on how the lender views your future requests to borrow.

Failing to make payments can hurt your credit, and you’ll need that to be in good order for future purchases like a home or car.

Personal Loans and Your Banking Needs

There are many excellent ways that personal loans can help you when you need a bit of extra cash. However, there are easily as many regrettable ways to use personal loans, resulting from poor decisions and poor planning.

Keeping your finances in order is a big part of staying financially healthy. Personal loans have the power to help you or hurt you, depending on how responsible you are in making your decisions.

Personal finances can be tricky, but getting a personal loan doesn’t necessarily make them easier. Used frivolously or as a crutch for poor spending habits, personal loans can be terribly detrimental; you run the grave risk of getting in over your head and having too much debt to be able to save for the future.

But, used wisely, personal loans have the power to transform a bad situation into something tolerable, or even good. Like many other financial tools, personal loans are only as useful as the decisions behind them.

Know your options, make a budget and stick to it, and plan for your financial future, and any personal loans you get will be the safety net they were intended to be.

For more information on personal loans, contact Partners Financial FCU at 800-321-5617 or click here to apply today.

Additional personal loan resources:

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