Personal loans are not a solution for most financial situations, most times; they are just a Band-Aid on improper money management.
A situation where we recommend a personal loan is if you have credit card debt with high interest rates. Paying off debt with a high interest rate, such as a 24% annual percentage rate, can be difficult because the more interest you owe, the higher your payments will be and the longer it could take you to be debt-free. But if you qualify for a personal loan with a much lower interest rate, you can pay off the debt faster and spend less on interest.
One bad reason to take out a personal loan is to invest in the stock market; there is no reason to go into debt just to get money in the market. Save and then invest.
Some of the worst uses for personal loans are vacations, weddings, engagement rings and other unnecessary expenses. If you’re having trouble saving for an expense like a wedding or vacation, delaying it until you can pay for it in cash is a better option than a personal loan.
Personal loans are also not a good idea for home repairs. It’s usually better to use a home equity loan that taps the equity built up in your home, since home equity loans usually have lower interest rates.
Personals Loans vs. Payday Loans
While personal loans are offered by trustworthy lenders, payday loans are predatory, often signing up borrowers for debt that takes several cycles to pay off. A payday loan is a short-term loan, usually limited to a few hundred dollars. The borrower agrees to pay the lender the amount of the loan plus interest, and writes a check or gives access to their bank account. The lender then deposits the check when the loan comes due, which is typically the borrower’s next payday. However, if the borrower does not have enough money in the bank at that time, the lender will usually extend the loan until the next payday.
Most payday loans have exorbitant interest rates, often around 400% APR and sometimes up to 700%. Many borrowers end up extending their loans several times over. Because the interest rate is so high, they struggle to repay the loan.
Subprime lenders that don’t care about a customer’s ability to repay are probably counting on them not being able to pay the loan back on time. This sounds counterintuitive, as lenders might be out of business if customers can’t repay loans. But lenders commonly extend the loan’s repayment term in exchange for charging additional fees or interest. This practice is known as rollover or sometimes reborrowing if a person is paying one loan off and then immediately taking out a new one to meet other expenses. Payday loans that continue to roll over with additional fees or interest are how consumers get trapped in a nasty cycle of debt.
A payday loan is never a good idea, especially if you’re having trouble making ends meet. They can lead to bigger financial problems and can often cost you far more than you originally borrowed. If you find yourself contemplating a payday loan, consider borrowing money from family or friends, or sell something you own.