One can’t ignore how personal loans help us cope with financial emergencies or afford things that we might not otherwise be able to at the time. You may live frugally and ecologically but we still need to live in the real world world, unless you are the moneyless man. Since these loans are “unsecured”, you don’t even have to pledge anything – like your house or car. Interest rates are also way lower than those for credit cards. The best part – you get the flexibility to use the funds the way you like.
But that’s also where the problem comes in. You end up using the loan amount for things that might seem tempting at the moment, but could eventually lead you into a debt trap. And once you are there, there is no quick way to get out of it.
This leads one to a natural question – is there any such thing as “bad use” of a personal loan? Yes, there are quite a few of them. We have listed five such situations where using a personal loan may not be a good idea.
1. Funding Education
True, good education has become a necessity. However, with ever-increasing costs of getting into prestigious institutions, there are very few who can afford to pay out of the pocket. A personal loan for funding your own or your child’s education might seem like a good idea, but it’s not.
There are many reasons for that – the most important one being the “no waiting period”. This means that your personal loan repayment starts immediately and you have to pay a fixed principal amount, along with the interest, every month while you or your child are still studying.
Fortunately, you have the option to take an education loan, which is not only cheaper than personal loan, but also allows you to complete your studies and maybe even find a job, before the monthly repayments start.
2. Refinancing Smaller Loans
It’s very common these days to take a personal loan or a debt consolidation plan for refinancing high-interest debt. It saves a lot on interest charges and ultimately results in bigger savings for you. However, it’s not the best idea if the loan you are refinancing is too small to actually help you save anything. Worse, you might even end up paying more than you would pay without refinancing, especially if you don’t factor in all the costs such as processing fee.
In such situations, it’s best to avoid taking up a personal loan. Instead you should focus on quickly knocking out the remaining balance by increasing your monthly repayments.
3. Gambling or Investing in Shares
Avoid taking a loan for gambling or for investing in the stock market. It is okay to take risks and dream big, but not with borrowed money. If you end up losing your invested money, it can seriously damage your financial position and your ability to repay the loan. Before you might even realise, you will be in big financial trouble.
4. Home Renovation
If you are planning to use a personal loan for home renovation, you might need to reconsider. The better option is a home improvement loan, which is not only comparatively cheaper but also qualifies for tax exemptions in some countries. Whether it’s a new property or an old one, such loans cover all types of renovations.
5. Financing Your Business Expansion
If you own a business and it’s doing fairly well financially, avoid using a personal loan to fund your business growth. Instead you should consider applying for a business or commercial loan that will be much cheaper than a personal loan. Apart from that, there are other options as well, such as bringing in an angel investor. With an angel investor, you will have to dilute your ownership and profits, but you will be able to grow your business.
Personal loans should only be taken when there is a financial emergency. But what if you see an emergency every time you are in need of funds? How do you decide whether a personal loan is the best option for you?
The key is to carefully weigh the pros and cons of using a personal loan in the context of your particular situation and then decide what works best. If you think using a personal loan makes sense, make sure you have a plan to repay the amount without falling into a debt trap. Also make sure you’re considering the interest rates, monthly repayment amounts and processing or prepayment fees.