No matter your reasons for considering a personal loan, you’ll want to ensure your borrowing for the right reasons and that you know the best way to use your loan. For example, some people prefer to open a low-rate credit card. However, in other circumstances, a personal loan is the best course of action.
Read on for three great ways to use a personal loan.
Use a Personal Loan to Save Money
If you qualify for a personal loan at a lower interest than what you already pay for a credit card you carry, this may be a good opportunity to save money. Let’s look at an example:
Let’s say you qualify for a personal loan of $5,000 at an interest rate of 12%, and you also carry a credit card with a limit of $5,000 at 21.99% APR. If you knew you would need to spend $5,000, you could use the personal loan to make necessary purchases instead of the credit card and save roughly $500 in interest payments in the first year.
Use a Personal Loan to Get Out of Debt
Many people tap personal loans as a way to consolidate debt and pay it off faster. As illustrated in the example above, credit card interest rates may be much higher than the interest rate one can qualify for with a personal loan.
If you’re able to qualify for a loan with a lower interest rate than you’re currently paying for credit card debt, you can cut your total interest payments significantly and potentially pay off debt sooner. An added bonus is that consolidating credit card debt under a personal loan streamlines monthly payments. Rather than keeping track of multiple due dates and amounts owed each month, you can consolidate all debt into one monthly payment to one lender.
Use a Personal Loan to Boost Your Credit
While each person’s unique financial situation may play out differently, a personal loan may present the opportunity to boost your credit score. One way this happens is by diversifying your mix of credit.
Many credit scores consider your “account mix.” This credit scoring model looks at all your different credit accounts, such as installment and revolving accounts. The former refers to accounts that include personal loans, student loans, and mortgages while the latter refers to accounts like a credit card. If you currently have no installment loans on your credit report, a personal loan could help improve your rating.
Another way a personal loan may bolster your credit score is by reducing your high “debt” usage ratio. When credit scoring models consider this ratio, they’ll compare your available credit limit of any revolving accounts to your outstanding balance. If your balances exceed 25% of your available credit, you can assume it hurts your credit score. This is why it is important to focus on paying down this type of debt. Even for those struggling to pay down credit card debt, a personal loan could help as the debt usage ratio does not factor into installment loans.
While you must consider your complete financial picture before making a decision about personal loans, there are several ways in which a personal loan could be beneficial. Doing your due diligence and considering the entire repayment picture can help you come to the right decision for your unique needs.