When taking a personal loan makes sense vs when it doesn’t
One of the best things about a personal loan is its usage flexibility as it can be used to meet any requirement, unlike its counterparts like a home loan or a vehicle loan. However, it’s the same usage flexibility that makes this unsecured financing facility dearer too. Yes, the collateral-less personal loans come with steeper interest charges when compared to other loans.
But notwithstanding the usage flexibility, it makes a lot of sense to closely evaluate the purpose of availing a personal loan before taking the plunge. The added caution will work in your favour as any laxity in repayment would mean debt creation and a damaged credit score. Here are some pointers to help you understand which scenarios better warrant personal loans versus scenarios when they don’t.
When taking a personal loan makes financial sense
The high-interest charging personal loans are best channelled towards an appreciating asset. The mathematical argument is that the increase in the value of the asset boosted by the loan-led investment would offset the interest incurred in the long term. Here are some scenarios when taking the loan makes sense:
- Home renovation
Going by that argument, it does make financial sense to use a personal loan for home renovation, something that will add to the value of your house, especially when you don’t have adequate funds to go about them. Things like urgent repairs and renovation can be done with the help of a personal loan. That being said, there’s also another option out there – a home renovation loan, that might turn out to be a cheaper option. But these loans often come with additional riders (like only the owner of the house can get such a loan, 100% of the work estimate unlikely to be covered, etc.) and may involve extra paperwork and even bank inspection.
- Professional course or certification
Another scenario where a personal loan can boost the value of things is to use it to fund an educational/professional course or a certification programme. The course or certification will likely strengthen the career prospects of the loan applicant, something that could accelerate the chances of a better-paying promotion or a lucrative job change.
- Credit card debt consolidation
Getting a personal loan to consolidate or clear off spiralling credit card debt is another example of a wise usage, mainly because of three reasons. Firstly, the interest charged by credit cards is generally higher than a personal loan; so paying it off with a personal loan will likely translate to savings in interest payout. Secondly, clearing the debt and repaying the personal loan will improve the credit score which might’ve seen a slump following the missed credit card payments. And lastly, consolidating multiple credit card dues into a single monthly payment provides clarity and peace of mind. However, before making such a move, closely evaluate the interest rates applicable to your credit card(s) and the personal loan, and go for it only if you think it makes a major difference.
Well, mathematical considerations hardly matter when you’re tackling an emergency (like a sudden job loss, medical emergency, family emergency, etc.), and a personal loan often comes to the rescue of the cash-strapped. Getting one ensures quick liquidity, and also safeguards dignity. That being said, it’s ideal if you have in place an adequate emergency fund and a health insurance plan to be better-prepared in tackling emergencies.
When taking a personal loan doesn’t make sense
You’ll be well-advised not to get carried away by the fact that a personal loan is readily available (well, we all get calls from the bank, don’t we?) and it can be used to meet any requirement. Here are some scenarios for which you should seriously reconsider taking a personal loan:
- Daily expenses
Avoid taking a personal loan to fund daily expenses like groceries and house rent if you’re going through a financial crisis. Remember, personal loans are fairly high-interest charging loans that need to be repaid in full on time, failing to do so can further deteriorate your financial situation. Again, always have in place an emergency fund with at least 3-6 months’ expenses to bail you out of a tough situation.
- Lifestyle expenses
Many would argue that it’s okay to take a personal loan for expected lifestyle expenses like lavish international vacations or other luxuries like expensive furniture and gadgets. But we disagree. Expected self-consumption-linked spends are way more satisfying when funded by your own money, not with borrowed money. Remember, your trip will end in a few weeks but your loan EMIs will continue for a long time, something you might regret later.
Best is to have in place specific financial goals to meet your big-ticket lifestyle spends and set precise timeframes to achieve them. Once you’ve clear goals, calibrate your savings allocation and channel your investment returns to meet them within the timeframe.
- Investment capital
If you’re new to the world of investments, you may want to reconsider your decision to raise your investment capital with the help of a personal loan. Simply because low-risk investments’ tax-and-inflation-adjusted returns might not be enough to offset the interest you need to pay with your loan. And investment instruments that can fetch higher returns than your loan interest will likely be riskier too. That being said, if you’re a seasoned investor with expertise in investing in riskier and volatile but lucrative tools like stocks, you may see merit in taking the loan route.
In conclusion, a pragmatic approach when it comes to taking a personal loan will definitely go a long way in boosting your overall financial wellbeing.