Personal loans typically come with more competitive interest rates than other lending products, such as credit cards and credit card cash advances. Because of this, they could save you money in the long run while giving you the flexibility to use the funds however you see fit.
Some of the ways to use a personal loan to keep more money in your pocket include consolidating high-interest credit card debt, financing a major expense and even as a tool to increase your credit score so that you can obtain more competitive interest rates on future borrowing.
When should you use a personal loan?
The answer to this question depends on your unique financial situation and goals. For example, using a personal loan can be a good idea if it helps you cut down on high-interest credit card debt by allowing you to secure a lower rate than what you currently have. Using one could also be a smart move if it helps you pay for a home improvement project that adds value to your home.
But there are some scenarios where using a personal loan could be less than ideal. If you can qualify for a cheaper financial product, like a 0% APR credit card, using a personal loan might not be the best move for you. Taking out a personal loan also wouldn’t make sense if you couldn’t afford to repay it since you’d face late fees and potential damage to your credit.
If you have fair or poor credit, it may be best to work on your credit score before applying for a personal loan as you could end up with an interest rate as high as 36 percent.
Below are five ways a personal loan could help you save money:
1. Consolidate credit card debt
One of the most common uses of personal loans is to consolidate high-interest credit card debt. Personal loans typically have lower average interest rates than credit cards. The average credit card currently has an interest rate of 20.49 percent, while personal loans have an average interest rate of 11.05 percent.
However, to qualify for the lowest rates, you’ll need a credit score upwards of 700. If you don’t have time to wait until your score improves and need to tackle debt fast, you can also apply for a loan with a co-signer or co-borrower with good credit to increase your chances of getting the best rates.
Why this saves money: By obtaining a lower interest rate with a personal loan, you’ll spend less out of pocket each month on interest charges and over the life of the loan. A reduced interest rate may also free up cash for you that can be applied to pay down the debt principal more quickly.
2. Finance a big expense
If you decide to take out a personal loan for a want and not a need, calculate your loan payments to see if you can afford to repay the loan comfortably without destabilizing your budget. Using a loan calculator may help.
Why this saves money: Using a loan to finance a big expense rather than a credit card can save you money, as you can potentially lock in a lower interest rate. What’s more, since personal loans are cold, hard cash, you may be able to get a better deal, depending on what you’re planning to use the money for.
3. Ditch high-interest debt
If you’re struggling with high-interest debt, whether it’s an older loan or a past-due medical bill, a debt consolidation loan could help you cut down interest plus pay off debt faster. Ideally, the interest rate on the new loan should be lower than the rate you currently have, so you’re spending less overall on interest charges.
Consider paying more than the minimum due each month to possibly save hundreds or even thousands of dollars in interest. Before you do this, make sure your lender doesn’t charge you a prepayment fee.
Another alternative to using a personal loan to ditch high-interest rates is to focus on paying down your debt using the debt snowball or debt avalanche method. Depending on your debt and your financial situation, that may work out better than taking out another loan to pay off your debt.
Why this saves money: By consolidating multiple debts into a single loan with a lower interest rate, you can reduce the interest charges you’re paying each month. This step may also free up some cash in your monthly budget that can be used to pay off your debt more quickly, saving you hundreds or even thousands on interest over the life of the loan.
4. Increase your credit score
Beyond saving money, a personal loan can boost your credit score. If you have credit card debt and spend close to your spending limit every month on your cards, your credit utilization ratio will increase.
Lenders will consider you a higher risk. High-risk borrowers are often charged steeper interest rates making any future borrowing more expensive for you. Personal loans can help with credit utilization if you use the loan proceeds to pay off your credit cards.
If you have little-to-no credit history, a personal loan could also be a great tool to boost your credit if handled correctly. That is because it will contribute to your credit mix and payment history, both of which account for 10 percent and 35 percent of your credit score, respectively.
Why this saves money: Increasing your credit score allows you to qualify for more competitive interest rates when borrowing money, whether for a mortgage, car loan or any other type of borrowing. When you can obtain the most competitive interest rate possible, borrowing money costs you less.
5. Avoid pesky pop-up fees
While credit cards and other credit products tend to come with fees attached to them in addition to interest, some personal lenders, like SoFi and LightStream, don’t charge any of these. Fewer fees automatically translate into bigger savings down the line. However, very few personal loan lenders offer this, and those that do typically require excellent credit and a stable source of income for you to qualify for its products.
Why this saves money: Being a savvy borrower and avoiding unnecessary and unexpected fees can save you hundreds or even thousands of dollars over the life of a loan agreement.
The bottom line
Personal loans can save you money in a number of ways. However, taking on a loan you can’t afford for wants should be avoided, if possible. Doing so can put you in a bad spot financially and ruin your credit if you miss a payment or default on the loan.
This article originally appeared here and was republished with permission.