One of the advantages of a personal loan — a debt, usually unsecured, that you pay back in installments — is that unlike an auto, student or mortgage loan, it’s not allocated for a specific, limited purpose. Instead, you get a lump sum of cash, which you can use for just about any purpose you choose.
So what do people actually use personal loans for? It’s hard to come up with precise data, since lenders don’t ask. But two recent studies on borrowers and personal finance, along with some input from advisers and experts, give some insight into why people apply for personal loans, and what they use the money for.
1. Dealing with Debt
A September 2019 study released by credit reporting firm Experian, one of the three major credit reporting companies in the U.S., looked at 210 consumers who were considering taking out a personal loan for the first time. Forty percent wanted the money for debt consolidation — that is, paying off existing loans, such as credit card balances, and replacing them with a single monthly payment, often at a lower interest rate. Similarly, a study of LendingTree customers, released in January 2020, found that around two-thirds of those who inquired about personal loans wanted to deal with debt in some way, with debt consolidation accounting for 35.7 percent of borrowing. Refinancing credit card debt to get a lower interest rate contributed another 31.4 percent of borrowing.
“Many people use personal loans to consolidate debts, much in the way that some people have used balance transfer cards over the years,” Matt Schulz, chief industry analyst for LendingTree, an online marketplace that helps consumers to shop for and compare loans, including personal ones, says in an email interview. “Zero-percent balance transfer cards can certainly be a cheaper way to go, but for many folks who want nothing to do with credit cards after running up big debts over the years, personal loans can be a pretty appealing option.”
2. Home Improvement Projects
In the Experian study, 35 percent of people who inquired about loans were considering applying for a loan to finance a home improvement project.
“2018 was a robust year for overall consumer spending on home services, with average home improvement spending at $7,560, average home maintenance spending at $1,105, and average home emergency spending at $416 — for an overall total average spending of $9,081 across all categories,” according to HomeAdvisor.
3. Purchasing Big-ticket Items
Experian found that 27 percent of potential loan seekers said they might use the money to make some unspecified large purchase. That doesn’t necessarily mean that they have to finance the entire item with the loan, according to Rod Griffin, director of public education for Experian.
For example, “if I’m buying a new car, one of the options I have, if I don’t pay cash in full and have a small amount left, is that I can use a personal loan to pay the small remaining balance,” Griffin explains. “Maybe it’s just a few thousand dollars. From personal experience, I know that when the balance is below a certain amount, a bank may not want to make an auto loan, because not enough will be owed for it to be profitable.” A modest personal loan can bridge that gap.
4. Travel
Twenty-three percent of people who are looking at taking out a personal loan would consider using the loan to pay for travel, Experian found. That’s understandable, since vacations can be pretty costly. A 2019 study by personal finance website Bankrate found that for the 52 percent of Americans who were planning a vacation that year, the average anticipated cost was $1,979, with older millennials in their 30s — a prime age to travel — expecting to spend $2,366.
As this article from LendingTree notes, using a personal loan to pay for travel has pluses, in that you don’t have to delay gratification, and it may be cheaper than putting a trip on a credit card. On the downside, because of interest, you end up paying more for the trip than if you had saved up the cash, and you face the usual risks if you borrow too much money and have trouble paying it back on time.
5. Medical Bills
While health care costs don’t show up in the Experian study as something that people frequently list as a reason for applying for a personal loan, financial advisers say that many actually turn to such borrowing after they suffer a serious illness or injury.
“A stroke, cancer, heart attack or major car accidents can cause extremely high medical bills,” explains Dwain Phelps, founder & CEO of Phelps Financial Group in Kennesaw, Georgia. “There are expenses that your insurance will cover and expenses that your insurance will not cover, which become your responsibility. Now think about those individuals who don’t have health insurance, their medical costs and expenses could get out of control. A personal loan could help with those unexpected medical costs.”
6. Starting a Small Business
Personal finance experts say that people who are trying to launch new ventures — especially home-based ones that they want to pursue while still holding down their day jobs — sometimes turn to personal loans for seed money. “Entrepreneurship is another legitimate reason for borrowing,” Griffin says. “You may need to purchase software or computer equipment.” The needed capital might be too little to make it worth applying for a business loan, but a personal loan will work just fine.
7. Unexpected Expenses
It could be a broken-down air conditioner in the middle of summer, or a cracked muffler on that old car that you need to get to work every day. Experts say yet another reason that people sometimes turn to personal loans is that they need to cope with some sudden setback they didn’t anticipate. According to a 2018 report from the Board of Governorsof the Federal Reserve System, four in 10 U.S. adults, if faced with an unexpected expense of $400, would not be able to come up with the cash unless they sold personal possessions or took out a loan.
“The reasons for borrowing money are complicated, and it varies for different people, but one thing I think is a unifying theme in our country is that millions of Americans who are working hard are still struggling hard to get by day to day,” explains Christopher Peterson. He’s director of financial services for the Consumer Federation of America, and a law professor at the University of Utah who focuses on consumer protection.
But taking out a loan to cover an emergency can lead to trouble down the road, if a person has more bad luck. “Credit can be risky because if you’re borrowing to deal with a problem today, you may have the same problems tomorrow,” Peterson cautions. “But you’ll be less equipped to deal with it because you’ll still be paying of the previous debt.”
Source: https://money.howstuffworks.com/personal-finance/debt-management/reasons-for-personal-loan.htm
