Unsecured personal loans can pay for almost anything. Their flexibility makes them easy to turn to when you want to consolidate your debts or put in that kitchen island.
But first assessing all your financing options can save you money. As the economy shifts, so will the way a personal loan fits into your plans.
Right now, for example, the cheapest way to get extra cash might not be with a personal loan, but with 401(k) funds. The government is allowing penalty-free withdrawals from these savings for those affected by COVID-19.
Still, withdrawing money from your 401(k) could mean you lose out on potential market gains and set your retirement plan back.
Even if an unsecured loan isn’t the cheapest, it may be the next-best option. Here’s what financial planners said about some of the reasons people take out personal loans.
Debt consolidation. A debt-consolidation loan lets you pull existing debts from different sources, like credit cards and other loans, into a single loan. It can save you money if you get a lower annual percentage rate on the new loan.
It’s also an option if you don’t want to pay off your debts from smallest to largest, also called the debt snowball approach, said Miami-based certified financial planner Angela Moore of Modern Money Advisor. That repayment method focuses on little victories, but it won’t save you time or interest.
She says what makes personal loans work well for consolidation is the end date they put on your debt. Credit cards, such as balance-transfer cards that can also be used to consolidate debt, usually have revolving balances and open credit lines that you can continue to spend against.
But if you have a habit of using credit cards, try to put those to rest before you commit to the repayment terms on a loan, says Sacramento-based certified financial planner Tony Matheson.
“I want to make sure that [people are] not going to just get into a deeper hole by compounding the problem with more debt,” he says.
Home improvement. If spending time at home is giving you the urge to renovate, personal loans are one way to pay for them.
They don’t require you to have home equity or use your home as collateral. But they often have higher interest rates and shorter repayment periods than home equity loans or home-equity lines of credit (HELOC).
The main argument for something like a HELOC is a low interest rate, Moore said. But she recommends treading lightly where you are borrowing against your home.
“If you do a home equity line of credit,” she said, the lender could take your home if you’re unable to pay back the money. “So, you’re trading something for that lower interest rate.”
Medical bills. If you are hit with a big medical bill you can’t cover all at once, a personal loan could cover it. But another potentially less expensive option is a low- or no-interest payment plan through the medical provider, Matheson said.
He recommends comparing the term lengths and monthly payments to decide which works best for your financial situation.
You can also work with a medical bill advocate, who can spot expensive errors and negotiate down costs to make your bill more affordable. Just be sure to ask about the advocate’s fees.
Helping someone else. Financial planners broadly recommend against getting a personal loan to help someone else.
Though he understands the urge to help, Wisconsin-based certified financial planner Ben Smith suggests reviewing what borrowing on someone else’s behalf may do to your own financial plans. Will lending the money derail your retirement plans or delay your dream of owning a home?
“It’s kind of like when you’re in an airplane and the flight attendant says, ‘Put on your own oxygen mask before helping others,’” he said.
Covering bills. Taking out a personal loan to cover a mortgage or utility bill is a case when getting a loan can do more harm than good.
If you are affected by COVID-19, this could be the time to consider a penalty-free withdrawal from your 401(k) instead, Smith said.
If you can’t make ends meet after cutting your budget, Moore said, you are probably looking at a larger lifestyle change, like moving in with your parents or selling your home.
“I think that people need to be thinking more long-term, more strategically,” she said. “I recommend finding ways to just reduce your needs — reduce what you need in terms of money by eliminating as many expenses as possible.”
Annie Millerbernd can be reached at email@example.com.