Loans

Is Taking Out a Loan a Good Idea?

Personal loans are one financial option for individuals that need money for unexpected expenses and bills. Taking out a personal loan can be a good idea when you want to invest in an asset, such as a car, or organize your finances. If you are overwhelmed by the amount of credit card debt you have, taking out a personal loan could even help you to consolidate your debts.

Taking out a personal loan may be a good idea, depending on your specific financial situation. Read on to learn more about the approval process when applying for a new loan.

Why You May Want to Avoid Using Your Savings

Financial advice you may have heard is to avoid taking out unnecessary personal loans. This is generally true. But there are instances when taking out a personal loan is a good idea and even preferable to dipping into your savings.

Financial emergencies can appear without notice, disrupting your established budget. For example, you may need to pay for car repairs or manage credit card debt. If you didn’t expect to pay these bills, then your budget may not cover the cost. 

When this happens, you may feel inclined to use the money you have readily available. But using the entirety of your savings account or dipping into your 401(k) plan to cover the cost of an expense should be avoided! 

Learn why taking out a personal loan instead of using your savings may be a good idea:

Avoid Excessive Fees for Using Your Savings

Depending on the type of financial account you have, withdrawing funds may not even be possible. 

Take a look at some fees you may have to pay for using the money in your savings account:

  • Early Withdrawal: Withdrawing cash before you are allowed can result in an early withdrawal fee. For example, if you withdraw early from a 401(k), you could face a 10% penalty tax and a withdrawal fee based on the total amount you withdraw. This could be thousands of dollars!
  • Insufficient Funds: Some savings accounts require a minimum amount at all times. If you withdraw too much money, you may be charged due to insufficient funds in your account.  
  • Excess Transactions: Some savings accounts limit the amount of money you can withdraw and the number of transactions you can make. If you withdraw funds more times than permitted, you will have to pay an excess transaction fee.
  • Early Account Closure: If you withdraw the entirety of your savings account, you could risk having your account closed. You may face early account closure fees if your account was recently opened and you don’t keep the minimum amount in your account.

Savings Help You Accumulate Interest

Using your savings may hurt you in the future. The benefit of a savings account is that you can earn a pretty penny through compound interest over time.

For example, a certificate of deposit (CD) is a popular savings account option for people that want to grow their money. Money is secured in an account for a set period, from a few months to several years. The more money you invest in a CD and the longer you leave it untouched in your account, the more money you could earn back. 

By withdrawing funds from your savings account, you are limiting your return on investment (ROI). It may be a better option to use a personal loan instead.

Getting started is easy, even if you don’t have a savings account yet. In as little as 30 days, you can save $1,000 by following money savings tips, such as eating out less and grocery shopping with a budget. You can learn how to save money over time, so don’t feel discouraged if you slip up and don’t stick to a budget plan right away.

Get Discounts on Important Expenses

Having cash readily available in a savings account could help you obtain critical financial discounts. While most people finance large purchases with a personal loan, cash could help you save more money.  

If you want to make an offer on your dream house, having a sizable down payment could help you get lower interest rates on a mortgage. A down payment of at least 20% is advisable and could help you get approved quickly for a mortgage. If you have your eyes set on a gorgeous contemporary house, the sooner you get approved for a loan, the sooner you can make an offer.   

Paying for a car outright may also help you negotiate discounts at a dealership. Dealerships often offer deals like waived fees and rebates for buyers with a good credit score. If your credit score is less than perfect, using cash to buy a car gives you leverage to negotiate a discount.

Can I Get a Personal Loan if I Have Poor Credit?

It may seem counterintuitive, but when you get an unsecured personal loan you could boost your credit score and restore your financial history.

While credit score inquiries can potentially lower your FICO score, successfully managing your credit card debt can reflect positively on your credit report. Having different credit accounts and paying on time could help your credit score improve over time. 

Credit scores higher than 670 can help you obtain better financial opportunities when you decide to upgrade your car or apply for a mortgage.

Is Getting a Loan a Good Idea if I’m Already Repaying Loans?

If you have multiple bills to pay each month, you may not think that taking out a loan is a good idea—even if you need it. Having to borrow money could further disrupt your finances. But with the right type of installment loan, you could get enough financial support to consolidate your bills!

One financial rule you may have heard is that you shouldn’t take out more money than you need. But there are instances when it is a good idea, such as using the extra funding for debt consolidation. For example, getting a quick cash loan could help you repair your home and pay off those upcoming bills.

If you need a loan to cover the cost of a $6,000 roof replacement, and you qualify for $15,000, you could use that extra money to pay off loans that have high-interest rates. Interest is the actual cost of borrowing money, and some loans may burden your finances with excessive rates. Getting a larger loan with lower interest rates could help you save more money in the long term and pay fewer bills.

Is a Loan a Good Idea Instead of Buy-Now-Pay-Later Options?

When considering purchasing items online, you may have heard of buy-now-pay-later (BNPL) options. These financing options seem like a good idea at checkout because they promote instant cash and the convenience of payments spread out over time. But taking out a loan may be a better option than settling for a buy-now-pay-later financing plan.

Taking out a loan is a good idea instead of using a buy-now-pay-later plan because you will likely pay less in the long run. Consumer financing plans typically have higher interest rates and more fees. They also do not offer the same financial security as traditional loans. BNPL creditors entice buyers with an easy process at checkout. Still, your finances may benefit more from taking out a loan instead.

Taking Out a Loan: Secured vs. Unsecured

If you’re thinking of taking out a personal loan, it’s a good idea to first learn about your options. When it comes to lending, there are two types of loans: unsecured and secured.

Lenders take a significant risk when lending money, so a strong credit score is usually the most crucial factor for qualification. Traditional loan options, such as bank loans, do not require an asset as collateral because your credit history indicates if you are a financially responsible borrower. It is still possible to qualify for unsecured loans with a bad credit score, but lenders may offer higher interest rates.

Secured loans require an asset as collateral because credit backgrounds are not always used during the qualifying decision. Secured loans were designed for individuals that may not be eligible for unsecured loans due to a bad credit score. The asset must be valuable enough to minimize the lending risk for lenders. However, using an asset means you run the risk of losing it.

Popular Options for Taking Out a Loan

When taking out a personal loan, you should consider certain factors to make borrowing money a good idea. Consider how much money you need, how much time you want for repayment, and if you’re going to use collateral.

Below are some popular options people consider when taking out a personal loan. But it’s important to review each option carefully, as some are very risky and costly:

Payday Loans

A payday loan is a short-term loan option for people that need quick cash. Payday loans are popular because collateral is not required for qualification. People with poor credit could still be deemed eligible. Although payday loans provide instant relief for medical bills, credit card balances, and other debts, there are many downsides.

The interest rates with payday loans can be excessively high–upwards of 400%! Repayment is expected within two weeks on your subsequent paycheck. If repayment on the payday loan cannot be made in two weeks, then the loan rolls over, and you could be stuck in a vicious debt cycle. 

Payday loans typically average a few hundred dollars. If you need more money for a major purchase, you would need multiple payday loans—which is not a good idea. 

Pawn Shop Loans

A pawn shop loan is a secured loan option obtained at a pawn shop. A pawn shop, also called a pawnbrokers shop, offers loans based on a small percentage of the value of the asset you use as collateral. 

Typically people pawn jewelry, electronics, instruments, power tools, and more. If the loan is not repaid to the lender on time, the store sells the asset. 

The cons of a pawn shop loan include high-interest rates and short repayment terms. The monthly payment amount is usually high because borrowers don’t receive a lot of time for repayment. And since the loan amount is based on the asset you use, you may not receive as much money as you need with only one asset. 

Pawn shop loans can be incredibly inconvenient even though funding is relatively quick. Plus, if you don’t repay on time you can lose your collateral.

Car Title Loans

Car title loans are also called pink slip loans, car equity loans, and auto title loans. The loan amount you could receive is based on the market value of the car. The monthly payment amount is based on how much funding you receive and your income. 

This secured loan option is popular because most people have a car in their name, which they can leverage for emergency cash. While convenient, title loans are extremely risky since you can potentially lose your vehicle.

Using your car as collateral means you risk losing it. If you fall behind on payments due to the sky-high interest rates, your car could be repossessed and sold at auction. If you only have one vehicle, that means losing access to reliable transportation. Even while repaying your car title loan, you could be prevented from driving to ensure the car stays in pristine condition. 

Personal Installment Loans

There are both unsecured and secured options when you want to get a personal loan. With a personal installment loan, you could get same-day cash for use on just about any emergency expense. There are options for individuals with good credit and even bad credit.

The monthly payments you receive will depend on your income and the loan amount you receive. The length of repayment varies based on the lender. Interest rates are generally more flexible with personal loans than other options. Still, it is always a good idea to conduct research before you decide to get a personal loan.

Why Getting Personal Loan Funds is Good Idea

Taking out a personal loan is a good idea if it will make your life easier in some way. Even if you have a savings account, using a personal loan may be the better option if it means you can continue to grow your money.

The purpose of taking out a personal loan is to improve your current financial health. Whether that means debt consolidation or expanding your credit history. There are ways to make personal loans work for your finances. The key is to look for personal loan options that work with your established budget and don’t strain your wallet.

A good personal loan will help you obtain enough money to cover the cost of an unexpected bill without overwhelming you with hidden fees or high-interest rates. Consider your personal loan options carefully and inquire before making a final financial decision. 

Be sure to ask questions about repayment before signing a financial contract. Make sure that your monthly payments will work with your income and established bills. Calculating your monthly expenses before looking into loans can significantly help you determine what you can afford to repay.

Even with bad credit, finding an affordable personal loan option is possible. So take your time deciding because it is only a good idea if you benefit.

References:
Calculate Penalties on a 401(k) Early Withdrawal