When are personal loans a good idea?

People, businesses and governments borrow money all the time to pay for things they need. Often, paying for a big purchase over time makes sense because you spread the cost out. A house is a great example of “good borrowing.” If you had to pay the entire amount upfront with cash, only the superrich would be able to buy one. So here are a few examples of times when it makes sense to borrow money.

  • 1. Buying something that will last

A home is an obvious example of something you’ll own for a long time. But so are cars, major appliances and essentials such as furnaces, which also last for years.

  • 2. Borrowing to improve your situation

Paying for continuing education or training for a new skill is a solid reason to take out a loan if it leads to earning more money, including the needed income to pay back that loan on time. Or perhaps you need to invest some cash to create a side-gig. Either way, a short-term investment in yourself can lead to lifelong rewards when you borrow sensibly.

  • 3. Borrowing now to save money over time

Using a personal loan to pay off high-interest-rate credit card balances can result in a smaller, single payment each month. But it only makes sense if you avoid loading up those cards again.

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When are personal loans a bad idea?

Borrowing money to pay for something you won’t own for very long can set you up for months or years of frustration and regret. Watching payments trickle out of your bank account with nothing to show for them is no fun.

Here are three examples of times when borrowing is a bad idea.

  • 1. You’re buying a one-time experience Borrowing to take a trip with your friends can seem like a great idea when you’re imagining the fun you’ll have. But the loan payments might prevent you from going on any more adventures for years.

  • 2. Your payments will prevent you from saving If your loan payments make it impossible to save any money for the future, build an emergency fund, or have any fun, the thing you’re buying might not be worth it.

  • 3. You’re paying too much for something Just because you qualify for a personal loan doesn’t mean you should use the full amount you’re eligible for or shop for the most expensive stuff. Buying used goods, from cars to appliances, will save you money and your payments will be smaller.

Personal loan basics

If you’ve decided that a personal loan is right for you, choose an amount that will still allow you to make progress on all of your other financial goals.

But before you click the “apply now” button, know what you’re getting yourself into. Here are the answers to some commonly asked questions about personal loans.

How much can I borrow?

How much you can borrow is based on your income, your credit score, and whether you have collateral (assets) to guarantee the loan.

How long do I have to pay back the money?

Usually, you can choose the length of your loan. Terms from six months to five years are common. The longer you take to pay it off, the more you’ll pay in interest.

How much will a loan cost?

There are typically no set-up fees on basic personal loans. The only cost is the amount of interest you pay over the life of the loan. Experimenting with an online loan calculator will help you estimate your payments based on various interest rates.

Getting the best possible interest rate is the best way to keep costs down.

What can I use as collateral for a loan?

Collateral is something that you promise to give the bank if you fail to pay off your loan. A loan that requires collateral is called a secured loan.

Common forms of collateral include:

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About the Author

John Ellis

John Ellis

Freelance contributor

John Ellis is a freelance contributor to MoneyWise.com.

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