Personal loans are a flexible type of financing that can be used for any purpose. They offer borrowers access to money quickly with the flexibility of repaying it in installments.
There are many smart ways to use a personal loan, such as: paying off high-interest debt, financing a big purchase, or consolidating debt. However, not everyone knows the smartest way to utilize a personal loan.
Paying Off High-Interest Debt
While putting a personal loan to this purpose may seem like overkill, it can help borrowers manage their debt better. As opposed to credit cards that typically come with cash advance fees, ATM charges and interest rates, personal loans offer a lower, fixed interest rate that takes care of any outstanding balances.
Personal loans also work well for paying off high-interest debts, including medical bills and other large, unforeseen expenses. Ideally, these should be paid off with emergency savings or a home equity line of credit (HELOC), but when such options are unavailable, a personal loan may help.
Additionally, personal loans are installment debt that doesn’t factor into your credit utilization ratio, which can affect your credit score. This makes it a smart option for those looking to improve their credit scores by managing their debt effectively.
Paying for a Major Expense
One of the best ways to use a personal loan is for a major expense that’s difficult to cover with savings alone. This might include a vacation that would otherwise be out of reach, expensive home renovations or buying a new car. It could also be a way to purchase necessities like new clothes and furniture.
People can also use a personal loan to pay for things like taking a professional development course or upgrading their home. However, it’s important to know how to smartly use a personal loan so that you don’t overspend or incur more debt in the long run. Another common way to make a personal loan smart is by using it for debt consolidation. This allows borrowers to bundle their debts into a single payment and pays off their debt faster.
Improving Your Credit Score
While it may seem counterintuitive to borrow in order to improve your credit score, taking out a personal loan and making timely payments can have a positive impact on your score. Using a personal loan to pay off debts or consolidate your existing loans could help you clear your debts faster while saving on interest charges.
Personal loans are typically reported to the major credit bureaus, meaning that consistent on-time payments can help you build a solid payment history and improve your credit score over time. This is particularly important when it comes to lowering your credit utilization and debt-to-income ratio, which both make up a significant portion of your credit score. Having a mix of different types of debt and a longer credit history can also benefit your score.
Taking Out an Emergency Loan for Medical Expenses
Taking out an emergency loan to pay for medical expenses can be one of the smartest ways to use a personal loan. It’s fast, easy and usually has a lower interest rate than credit card rates. Plus, you can build a good credit history with a personal loan by making monthly payments on time.
It’s best to compare rates and terms to find the best option for your situation. Also, before signing an agreement, make sure the monthly payments fit into your budget. You may be able to get help with your medical bills through local programs. If you don’t qualify for those, you can try to work with your physician or look for assistance from a medical charity. This is especially important if you don’t have insurance.
Consolidating Debts
Using a personal loan to consolidate debt is one of the most popular uses for this type of credit. Debt consolidation can help you save money by lowering your interest rate, pay off your debts faster and simplifying your monthly payments.
Before you take out a debt consolidation loan, make sure your income can comfortably cover your monthly debt service. It’s also important to check your credit report and fix any errors that may be negatively impacting your score.
Keep in mind that most debt consolidation loans come with fixed rates and a set repayment term. Once your loan term ends, you will be free from debt if you pay off the balance. However, debt consolidation isn’t a solution for people who are overspending or living beyond their means.