Ideally, you would never need more money than your savings allow. However, a sudden problem such as a medical emergency or high credit card debt could place a demand on your finances beyond what your savings can handle. At this point, taking out a personal loan to cover the costs could be your best choice.
Understanding personal loans
According to Bankrate, A personal loan is typically a fixed-term loan, meaning you agree to repay it over a certain period of time. Many of these loans are also unsecured loans, which means that you aren’t offering a house or car as collateral, making the interest rate higher than a secured loan. However, personal loans can potentially improve your credit score if you use them to pay for things like high-interest credit card debt. This is because a personal loan has a fixed end point, while credit card bills can continue to compound indefinitely.
Deciding to take out a loan
The decision of whether or not to choose a personal loan depends on your financial situation. Kat Tretina of Student Loan Hero points out that when facing rising credit card debts, a personal loan could carry a significantly lower interest rate, saving you thousands of dollars as more of your payments go to the actual amount you owe rather than paying off interest.
For a more specific example, Tretina calculated that with an average credit card interest rate of 13 percent and an average personal loan interest rate of 10 percent, a $10,000 debt would likely take 10 years longer to repay and would cost the borrower an extra $10,000 in loan payments if left on the credit card.
As strong as the potential benefits to a personal loan may seem, there are a few caveats to keep in mind. Among these is that a personal loan doesn’t help the root cause of the debt, so according to certified financial planner Adam Hagerman, part of the decision process is to trace the debt back to its source and see if there is a way to fix it. For example, is the debt due to uncontrolled credit card overspending, or was it a sudden emergency? Identifying the debt source will prevent a potential return to overwhelming debt.
Even though personal loans typically carry lower interest rates than credit cards, that doesn’t mean this will always be the case, particularly for those with low credit scores. Bankrate contributor Donna Fuscaldo recommends thoroughly researching several loan and credit card offers to find the best possible deal for your financial situation.
Armed with this information and the results of some useful research, you are now equipped to make a decision on whether taking out a loan to cover costs that your savings can’t handle is the correct choice.