Personal loans enable people to finance large purchases, consolidate debt, and ultimately improve their financial situation if they can use the funds efficiently.
Consumers who utilize personal loans to get ahead on their finances have lots of flexibility when it comes to disbursement and allocation of personal loan funds because it is treated the same as cash, with some lenders enforcing parameters on what the money can be used for.
Before you take out a personal loan, it’s essential to understand why you are choosing a personal loan over other forms of financing, and most importantly, how you are going to spend the money.
Are you going to finance a home improvement project? Consolidate debt? Or even build a cash cushion so that you can have some financial breathing room?
There are plenty of excellent options for utilizing funds from a personal loan, but there are also some purchases you should avoid if you want to save money on excess interest payments and fees.
In this article, we are going to describe how personal loans work when you should take them out, and ultimately some of the best ways to spend the money and use the funds wisely.
How Personal Loans Work
Personal loans are a form of debt financing offered by Banks, online vendors, and brokerages. Personal loans are generally unsecured at the core, meaning there is no collateral attached to the loan, and borrowers pay interest on the funds until the entire loan is paid off.
Lenders have various requirements for approving a personal love, but they generally require proof of identification, income, and use of funds.
To the lender, use of funds means what are you going to spend this money on if we approve the loan?
Once you are approved for a personal loan, the bank or lender will deposit the money into your account within a few business days, and you can use the money as you would any other deposit.
The loan terms dictate how many months you will pay for the loan, which can range from 3 to 72 months, or more depending on creditworthiness, how much you borrowed, and what your interest rate is.
Once you make your last payment, the loan account will close, and you will be finished with any other payments on the loan.
It’s vital to pay your loan payment on time every month so that you avoid any late payment fees or penalties.
Some lenders even allow pre-payments without any penalties, which means that if you have excess cash and would like to pay off your loan earlier than the date in your loan documents, you are allowed to do so without paying any fees.
Benefits of Personal Loans
There are many good reasons to take out a personal loan, including building up your credit score and having a set payoff date for your debts.
- Build Credit
A healthy credit score is a powerful piece of your overall financial health. Credit scores help lenders decide how creditworthy an applicant is, how much credit they are willing to issue, and even help you save money on interest over the long term.
Credit scores have a few components, including length of credit history, total balances owed, payment history, and more. Each piece carries a different weight, but they all combine to paint a brief picture of how you manage debt.
Consumers who have higher credit scores may be eligible for lower interest rates, higher balances, and longer loan terms because they demonstrated that they consistently pay their balances in a timely manner.
Regardless of your credit situation, you can apply for a personal loan, and there are many lenders on the market who work with all credit types.
- Enjoy More Flexible Terms Compared to Credit Cards
Personal loans have a decisive advantage over other credit types, including credit cards – they offer flexible terms with set payoff days and generally more favorable interest rates.
Credit cards are considered revolving credit lines, which means you can continuously add more to your balance as you are paying off a prior statement’s balance. Juggling revolving credit can lead to unforeseen interest charges, late fees, and balances that never go down.
Personal loans have set payment periods that range from 3 months to 72 months or more, and whatever your loan term dictates when the final balance will be paid off in full.
Using Personal Loan Funds
Now that we understand what personal loans are and how they function, let’s discuss some of the best uses of personal loan funds.
Since personal loans deposit a large sum of cash into your bank account, it can be tempting to use them for discretionary spending or spend it without a set goal in mind.
Some of the best ways to use the money are to invest in projects that can appreciate in value or make your life measurably better.
- Finance Home Improvement Projects
Many consumers know that improving the state of their home will make a living in it more comfortable and will also help increase its value.
However, building materials, labor, and unexpected renovation expenses can be expensive. Financing options include paying in cash which can be difficult for projects that cost thousands of dollars. Using a credit card to finance a large renovation can be tricky because interest rates on credit cards are usually high, which can make the overall cost of the project extremely expensive.
Personal loans are one of the best financing options for home improvement projects because there is a set payoff date, fixed interest cost, and access to higher credit limits than a standard credit card.
If you are approved for a personal loan to renovate your home, you can pay for the project with the peace of mind that a predictable monthly payment has a set termination date, and you will most likely increase your home’s value.
- Consolidate High-Interest Debt
Many households find themselves in the position of having too much high-interest debt. Although this is generally a gradual progression, it can become costly for most budgets to maintain interest payments on multiple credit lines.
Whether it is a variety of credit cards or a combination of revolving credit lines mixed with high-interest loans, personal loans can be a powerful tool in helping to consolidate debt and dramatically reduce interest expenses.
- So how can personal loans help reduce debt?
When you work with a lender who offers personal loans designed to consolidate debt, you use the loan funds to pay off all of the other lenders, and you are left with a single monthly payment instead of a bunch of higher-interest payments to many lenders.
Consolidating debt into one personal loan has a few significant benefits:
Reducing Overall Interest Paid – Revolving credit lines and other high-interest debt can quickly balloon into a large balance due to lower minimum payments and constant interest accumulation. Consolidating your debts into one single payment with a fixed interest rate will enable you to pay down the principal balance quickly and reduce the impact of high-interest rates.
Gain Control Over Your Cash Flow – Balancing many payments to a variety of lenders can make personal finances complicated and stressful. Instead of worrying about missing a payment to a handful of lenders, a consolidated personal loan will streamline your finances because you will only have one monthly payment to manage.
- Set An End Date To Revolving Credit Balances
Another powerful benefit of personal loans is that they have a set closing date when the loan will be paid off.
Many borrowers who find themselves trapped in an endless cycle of revolving credit often become discouraged because they don’t see an end in sight for their debt.
Thankfully, personal loans have a set term with the term is 3 months, 12 months, or more, when they will be paid off, and the account will close.
Having a set end date for your personal loan can be gratifying and rewarding because once the balance is paid off, you won’t have to worry about making payments on it anymore.
Finally, since the monthly payment on a personal loan is fixed, you won’t need to worry about minimums or late fees as long as you make your monthly payment.
- Finance A Large Trip
Personal loans can also help pay for a large trip such as a honeymoon, family vacation, or immersive experience in another country.
While shorter vacations may benefit from using travel rewards credit cards to earn points, booking a trip that costs thousands of dollars may benefit from a personal loan instead.
The primary reason to choose a personal loan for large trips is the flexibility and fixed payments that allow you to budget effectively for the trip while avoiding extraneous interest fees that many credit cards will charge if you do not pay the full balance.
Once you book your trip, you can enjoy the experience with the full confidence that it will be paid for with a fixed number of monthly payments which will not lead to a revolving interest nightmare.
- Build A Cash Cushion
You do not need to spend all of the funds when you take out a personal loan; in fact, you can keep the cash on hand if you are going through a transition such as a move or job switch (or both!).
When you get approved for a personal loan, the lender will deposit the cash into your account, and you can use it as you wish.
In some scenarios, this can be beneficial by having excess cash on hand if you need it, but you don’t want to drain your savings or investment accounts.
While there are some excellent ways to utilize personal loan funds to help you get ahead, some important details should not be overlooked if you are considering taking out a personal loan.
- Interest Rates
If you want to take out a personal loan, make sure to shop around and get a loan with interest rates that work for you.
Thanks to a variety of banks and online lenders, there are more options than ever before when it comes to finding a loan that suits your needs and budget.
Shopping for rates that work for you can help you save money and pay your balances down quickly.
- Wasteful Spending
Do not equate personal loan funds with free money. While getting approved for a personal loan and seeing a surplus of cash in your bank account may feel good at first, if you use the funds on wasteful discretionary spending, you may dig yourself into a hole if you are not prepared to commit to the monthly payments.
Tying Everything Together
Personal loans can be a powerful financial tool to help add value to your home, your budget, and your personal loan because they provide financing at a fixed monthly payment and interest rate.
If you have more questions about personal loans, check out our other guides and reviews!
* This content is not provided by the financial institution or the offer’s provider. Any opinions, analyses, reviews or recommendations expressed here are those of the author’s alone, and does not constitute a financial or expert advice.