When Are Personal Loans a Bad Idea?

Personal loans offer flexible funding to take care of emergencies and reach other financial goals. However, taking out a personal loan isn’t always a good idea.

Here’s what you need to know before you take out a personal loan.

Things That You Shouldn’t Use a Personal Loan for

Thanks to their flexibility, you can take out a personal loan to fund a wide variety of purposes, including financial emergencies, medical bills, and large purchases. However, there are a few items that personal loans shouldn’t be used for.

Even if you could use a loan for the following purposes without getting in trouble, there still might be better alternatives to taking out a personal loan. Here are some things to think about before you move forward with a personal loan application.

College Tuition

Many lenders make it clear that you shouldn’t use a personal loan to fund a college education. Additionally, a lender might not offer a high-enough amount to cover the cost of your tuition.

Consider federal and private student loans rather than trying to use a personal loan to pay college costs. Student loan interest rates might be lower, and getting approved for an education loan (especially a federal loan) might be easier than getting a personal loan. Carefully weigh your college funding options, including scholarships and grants, before you turn to taking out debt.

Home Down Payment

In general, you’re not supposed to use a loan to make a down payment on your home. Many mortgage lenders review where your down payment money is coming from and might not approve your mortgage application if you borrow money as part of the transaction.

Instead of trying to secure a down payment with a personal loan, you can apply for down payment assistance programs. Also, consider getting a family member or a monetary gift to help fund your down payment.

Business Expenses

As the name suggests, personal loans are supposed to be used for personal purposes. In many cases, if you plan to use the money to start or expand a business, you might not be able to get approved for a personal loan. A lender might even require you to affirm that you won’t use the money for business costs before they approve your application.

Instead of trying to get a loan for business costs, consider looking into a small business loan. You might be able to get a better deal—and you might be eligible for a tax deduction on the interest you pay for a business loan.

Investing

Some lenders specify in the loan documentation that you shouldn’t use the proceeds from the loan to invest. Besides, a personal loan might not be the best way to get the money needed if you want to invest. Personal loans often have higher interest rates than many investors see in annualized returns. As a result, you run the risk of paying more in interest than you gain from successful investment decisions.

Basic Living Expenses

Finally, it might not be a good idea to use a personal loan for your basic living expenses. In general, basic living expenses like groceries, rent (or mortgage) payments, utilities, insurance payments, and clothing should be paid for with budgeted funds.

If you find yourself regularly in a cash crunch and you’re thinking about getting a personal loan to get out of it, you might need to consider a new budgeting approach. Whenever possible, it’s better to cover basic living expenses with your regular income rather than taking on debt.

Other Items That You Shouldn’t Use a Personal Loan for

Most lenders specify that you can’t use your personal loan money for gambling. The possibility that you could lose the money by gambling presents a risk to the lender.

It hopefully goes without saying, but you also shouldn’t use a personal loan for illegal purposes. Loan documentation often addresses the issue of illegal activities, and the lender won’t provide you with funds if you won’t agree to use the money strictly for purposes that are in line with the law.

What You Can Use a Personal Loan for

As previously mentioned, personal loans can be used for a variety of purposes, including:

• Medical bills
• Replacing broken appliances
• Car repairs
• Vacation
• Major life events, like a wedding
• Home improvements
• Large purchases

Even though you can use a personal loan for many of these items, it might make more sense to plan ahead if you’re able. For example, if you have the ability, you could build an emergency fund that you can use for medical bills or car repairs. And rather than paying for a vacation, wedding, or large purchases by using a personal loan, you could create a savings plan and build a nest egg over time.

Carefully consider your overall financial situation and goals before you decide to go into debt using a personal loan.

The Bottom Line

A personal loan can assist you with various financial goals, in addition to helping you smooth your cash flow and/or getting out of unexpected expenses like medical bills. However, even though personal loans are flexible and can be used for several different purposes, they aren’t supposed to be used for everything.

Certain expenses, especially school and business costs, shouldn’t be paid for with personal loans. Additionally, it’s important to carefully consider whether paying interest on some of your spending makes sense. While you can use a personal loan to take a vacation, for instance, there’s a real possibility that you’ll still be paying down that debt years after you spent the money.

Before taking out a personal loan, carefully weigh the pros and cons, and decide whether the cost is worth it for your situation.