by Matt Frankel, CFP | Feb. 11, 2019
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Personal loans can be great financial tools in many circumstances. For example, if you need to pay for home repairs, you may be able to find a personal loan with more favorable costs than charging the repairs to a credit card.
Having said that, personal loans are not always the right choice. Sometimes, you’re better off looking for other types of financing, and sometimes you shouldn’t get a loan at all. With that in mind, here are three scenarios where a personal loan might not be the smartest move for you.
Personal loans can be excellent financial tools for many borrowers. They allow you to repay your debt with a fixed interest rate over a set amount of time, and the interest rates you can find on personal loans are often significantly better than those offered by credit cards -- especially if you have strong credit.
Having said that, if you do have strong credit, you can probably qualify for one of the best balance transfer credit cards on the market. To name one good example, the U.S. Bank Visa® Platinum Card offers a 0% APR on purchases and balance transfers for 20 billing cycles. Others offer similar 0% APR periods, and also have a variety of introductory offers and other benefits to choose from. And some don’t even charge a fee for balance transfers.
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The point is that while personal loan interest rates can be good, nothing beats 0% interest. If you’re reasonably sure that you’ll be able to pay back your credit card debt within the introductory period, you may be better off simply transferring your balance to another credit card. The same can be said if you need to make a major purchase -- say a home-improvement project that will cost a few thousand dollars -- and don’t need several years to pay it off. Many cards also offer attractive 0% APR periods on new purchases as well as balance transfers, so take a look at the best 0% APR cards on the market to see if one might better serve your needs.
To be clear, you don’t need excellent credit to get a personal loan. There are even some personal lenders that specialize in making loans to borrowers with fair credit histories.
Having said that, in order to get an interest rate that’s significantly better than you could find with a credit card, you’ll need a strong credit history. In fact, unless you have at least average credit -- a FICO® Score of 700 or higher -- you’re unlikely to get an APR of less than 20%. Some personal lenders offer APRs as high as 35.99%.
Meanwhile, the average credit card interest rate is about 17%, and it’s rare to see interest rates above 30%. The bottom line is that if you’re looking to save money on credit card interest, a personal loan might not be the way to do it if your credit score isn’t well above average.
Personal loans can certainly make sense for consolidating credit card debt. They can also be smart ways to finance things like medical expenses, auto repairs, and home renovations, just to name a few potential uses.
However, and this is the Certified Financial Planner® in me talking, there are also several things that simply aren’t worth going into debt over. For example, it’s generally not a smart idea to obtain a personal loan to go on a fancy vacation or to splurge on a new home theater. Don’t get me wrong -- I love going on vacation, and I have a pretty nice home theater setup in my own house. But, I purchased my home theater equipment with 0% financing, which I paid off before any interest kicked in, and I don’t finance any vacation-related costs that I can’t immediately pay for.
The bottom line is that personal loans can make a lot of financial sense in many circumstances -- but not always. Before you apply for a personal loan, it’s important to take a step back, evaluate your options, and also decide if borrowing money at all is a smart financial decision.
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