One of the biggest misconceptions about a loan is that simply, it is bad. For most people, they see it as an indication that they cannot fulfill their financial responsibilities on their own – that put simply, they are irresponsible.
While some lenders have a bad habit of maxing out every credit they can get, getting a loan is not necessarily an indication of poor financial health. In fact, there are a few proven ways to make personal loans work to your financial advantage. Used the right and responsible way, acquiring a personal loan right now might just be your way towards financial freedom.
Why personal loans?
A personal loan is different from other loans in one key aspect: what you use the loan amount for is entirely up to you. Of course, when you are applying for the loan, you may still need to disclose your reason for borrowing money. However, they are relatively more lenient in this department compared to an auto loan or an equipment financing.
Still, it is important to look at the bigger picture: you do not have to bet anything valuable against your loan (except your credit rating) in order to better your financial situation. When used properly, this is a low-risk approach with a high chance of success.
How does it help?
As discussed, a personal loan has no single use, making it a very powerful tool in paving your way to financial success. However, it goes without saying, that there must be some level of planning involved before you even start applying for one.
You should be able to answer this question: “Will this personal loan help leverage my financial position?” As you’d see, all the options I’d present to you here sufficiently answer that very question:
Consolidate your credit card debts
A credit card is a high-interest revolving debt. Basically, this means that you are paying huge interests every month on the balance that you have not yet settled. The more obvious solution is to simply pay the entire amount right away, but if that is not an option, a personal loan can be of great help.
Unlike credit card debts, a personal loan is an installment loan – the interest does not compound. Moreover, the interest rate is much lower than what credit card companies normally offer. Thus, obtaining a personal loan that covers the majority of the total amount of your credit card debts can help you in two ways: a) getting considerable savings on interest payments both in the short and long run and b) freeing up your lines of credit for future needs.
Boost your credit score
In relation to number one on this list, you can also get a personal loan to boost your credit score. Your credit card debts do not necessarily need to be sky-high for this loan to work in your favor.
Swapping credit card debts to a personal loan lowers your credit utilization ratio or debt-to-credit ratio, one of the factors considered in determining your credit score. So, for as long as you don’t cancel your cards after you settle your balance, you will see a boost in your rating.
Still, it is not recommended to enter into a personal loan agreement just in hopes of raising your credit rating. What you would pay in interests, no matter how small, is not worth it.
Augment funds for planned and emergency expenditures
At a glance, using loans for expenditures doesn’t make sense. So, early on, let me answer how spending on certain expenditures with borrowed money helps you financially.
There are two types of costs: the accounting cost and the economic cost. The former is the surface level – it accounts only for the monetary value exchanged in the transaction. On the other hand, the economic cost considers the accounting cost AND every other consequence of performing a certain action.
Let’s say you decided to have your home retrofitted with the funds you received from a personal loan. As a result, you lost money but now, you don’t have to worry about shelling out money on pricier repairs should an earthquake hit your area or perhaps on medical expenses due to a disaster-related accident.
Financially, it makes sense because it serves an insurance of sorts – you pay now so you don’t have to pay a lot later on.
Use personal loans to build another stream of income
A business loan may not be a viable option right now, but you can still fulfill your dreams of becoming financially independent. With the right business idea, a personal loan may just change your life for the better.
Some may argue that a home equity line of credit might be a more fit alternative for a business loan, but at least you don’t have to put any of your valuable assets at stake. Moreover, unless you need hundreds of thousands of dollars to get things started, a personal loan usually is enough.
Should you always resort to a personal loan?
While there are many benefits to getting a personal loan, it is not always the fit for your case. Assuming that you can qualify for this loan, I recommend that you study loan alternatives if any of these describe you or your situation:
- The amount you need is too high. In this case, you’d be better off with long-term and low-interest loans like home equity loan or home equity line of credit.
- You’re taking out a loan for someone else. Are you willing to get your credit rating potentially damaged by someone else?
- You already qualify for a loan meant for your purchase. Purchasing a car with a personal loan is not your best option, for example. A vehicle loan will get you an even lower interest rate because the car itself already serves as the collateral.
In any case, you should always evaluate and reevaluate your situation before taking out a personal loan or any kind of loan. Just like how it can be your way to financial freedom, it can also lead to your doom.
Robert is our in-house expert on personal loans and finance. He got an MBA, specializing in Finance, before joining the workforce. After working for multiple Fortune 500 companies in the past decade, he brings a wealth of knowledge and experience to the table.