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Contrary to what you may think about personal loans, there are certain circumstances when taking out a personal loan is a good idea, or may even be smart. You may be asking yourself, in what hypothetical situation would a personal loan be advantageous? Believe it or not, a personal loan is a vehicle meant to help consolidate and lower the interest rates of existing loans and repair credit, if done correctly, which is a big “if” in itself, I would say.
What is the difference between “unsecured” and “secured” loans?
“Unsecured” loans are funds you get without pledging collateral. Instead, lenders use your credit history and income to approve or deny the loan. The nature of unsecured personal loans is that you tend to have the freedom to use the lent money on anything, which has a huge window of opportunity to fall into the wrong investments. Unsecured personal loans tend to be among the highest annual percentage rates (APR) on the market and comes at a hefty cost if the money is spent recklessly.
Traditionally, secured loans are fixed and can only be spent on a certain investment category. These fixed types of loans like for example student loans or auto loans tend to have much lower interest rates. In most cases, you want to opt for a secure loan with the lowest amount of interest to pay off your debt much quicker when you can.
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When is taking out a personal loan a good idea?
1. Consolidate credit card debt
The APR (annual percentage rate) of a credit card can range upwards of over 20% depending on your credit history and score alone. By opting for a personal loan, which tends to fare much lower than a credit card APR, you may be able to pay off all your credit card debt and slice the number of monthly payments you’d make. The amount of money you’d save could pay off dividends alone.
If you hold any sizable amount of credit card debt, I strongly recommend you to plug your debt into NerdWallet’s calculator and see how much you could save on credit card debt by paying with a personal loan on a monthly basis. The savings amount should be enough of a motivating factor for you to consider this money move (see what I did there?).
An alternative to opting for a personal loan is to see if you qualify for any of the 0% transfer balance credit cards on the market like the Chase Slate credit card. Balance transfer credit cards like these exist to help buy credit card debt holders’ time. Precious time that can be used to figure out a game plan to pay off all your credit card debt. There are sometimes credit card offers that allow up to 18 months of 0% APR. The hardest part is just being approved because most people who hold credit card debt tend to have much lower credit scores, but if you do get accepted, much power to you.
2. Pay off any other existing high-interest loans
Besides credit card debt, you may still have other loans that may vary from a wide range of APRs. The concept is the same as consolidating credit card debt. We are not reinventing the wheel here. We want to cut the amount of interest during the lifetime of the loan as much as possible if you are able to get a personal loan approved with a much lower interest rate.
A good example of this is finding refinancing options for a student loan that has a higher rate than the APR of your personal loan. You want to have a personal loan that could pay everything off while benefiting from a much lower APR.
3. Pay off a wedding
Contrary to what most people would think maybe considered reckless spending, a wedding in my opinion is another viable option for a personal loan. I know by calling this “smart” it defies the idea of living within your means, however, I am one to believe that the moment of your life should be priceless so my opinion may be controversial.
A lot of people receive money from their parents or loved ones to help fund the wedding, but not everyone has that luxury or privilege. I believe paying off a wedding with a personal loan under the assumption of being financially independent and responsible is the way to go if there is no other means of receiving funds to pay for a wedding that is inevitably going to happen anyway.
In no way is paying off a wedding with a personal loan logically financially smart, but it is “smart” if you actually think about your values and are truly financially responsible.
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