Thinking of borrowing a loan?
But does that mean all personal loans are a bad idea? Does it even mean all student loans are a bad idea? The answer is that it depends.
In the sections below you’ll find the top 3 benefits of loan borrowing. Read on, to discover when loans are a good idea and when they’re not. You may be surprised by the answer.
1. Borrowing a Loan to Lower Your Interest Rates
We’ll start with loan borrowing 101. Whenever you take out a loan, you must consider the long-term consequences. Will the benefits outweigh the drawbacks?
Let’s take student loans for example. It’s poor planning to take out a loan to pay for your education. It’s excellent planning to take out a loan for the promise of an increased monthly salary.
In theory, that’s what a college degree does: increases your earning potential. Unfortunately, tuition prices have increased steadily over the past 10 years. The sheer number of college graduates has also shot up over the last 30 years.
That means the value of both undergraduate and graduate degrees has decreased. That’s especially true for many of the so-called “soft” majors which include most of the humanities. Think sociology, languages, visual arts, etcetera.
Many who graduate with these degrees from an expensive college find themselves in debt throughout adulthood. They can never quite afford to pay off those loans.
So, when are personal loans a good idea? When incurring some debt now will lead to a big payoff in the future. A good example would be borrowing student loans for science majors like engineering, chemistry, or physics.
You could also borrow for an immediate payoff. Lowering your interests is an excellent example of this strategy.
Each of your loans comes with an annual percentage rate (APR). It’s the amount the institute charges you each year for your loan. That’s how they make their money.
If the APR is high, it’s worth your while to apply for other credit cards with lower APR. You pay less.
Well, each business and personal loan comes with its own APR. If you’ve taken out a loan with a high APR, then trade it in for one with a lower APR when you qualify.
2. Borrowing to Consolidate Debt
Debt comes in many forms. These are only a few examples:
- Student loans
- Home loans
- Vehicle loans
- Credit cards
- Business loans
It’s common to accrue debt from multiple sources such as medical bills, vehicle loans, and credit cards. You learned in the section above that these loans may have different APRs. In that case, it may be worth your while to consolidate them simply to skip to a lower APR.
But it’s not the only reason.
Whenever you have multiple loans, you run a higher risk of missing payments. Or, worse yet, trying to juggle your payments and their due dates. That’s when things grow complicated.
When you try to pay the minimum amount due on more than one debt it’s easy to miss one. It can not only be frustrating but also rack up more interest or other penalties.
By taking out a loan to pay off several of your debts, you can consolidate your payment schedule to one date with a single payment. You know exactly how much it will cost you, so you’ll know exactly how much you must pay each month. No more juggling.
You can use this same strategy for large planned expenses, such as weddings or vacations. The only difference is that you take out the loan before the event. In that way, you avoid accruing many smaller debts.
If you take this approach, we recommend you follow these steps. Do your research to determine how much your planned event will cost. Then, when your certain you have a rock-solid number, tack on an extra 15%.
Things fluctuate, and unexpected costs are a part of life. Plan for it. You can always return what you borrowed if you don’t use it.
3. Borrowing to Bolster Your Credit Score
The third and final reason on our list of why to borrow a loan is to improve your credit score. Your credit score is the primary determining factor for how much lenders will loan you. The higher your score, the more they’ll loan you.
The other parts of that equation include the total debt you already owe and your visible income. When you’re looking at larger loans, like those for a home, total debt and income are crucial. Smaller debts, like cellphone contracts, only check your credit score.
But what do you do if you have terrible credit or none whatsoever?
That’s when you apply for credit cards with a small maximum. They usually come with high APR, but it’s the cost of improving your credit. Citi, Chase, and Capitol One tend to come with high APRs.
You can also take out incrementally larger personal loans.
Start with a small one. Payday loans, for example, will loan you up to $750 without a credit check. You can pay them back over a 90-day period and improve your credit score.
You could also do the same with your bank. Getting your bank loan approved is a much more difficult task, but it pays off. So long as your total debt remains low, banks will loan you more money each time you pay off a loan successfully.
This process is common for people who have little credit and wish to buy a house. The banks want evidence that you’ll be a reliable borrower.
Remember, there are many reasons to borrow a loan. The key is to use them strategically. Don’t think only about the loan’s immediate usefulness.
Think about how that loan will affect you and your credit long term. Will it improve your credit rating or your monthly income? If not, it probably isn’t a good strategy.
Thanks and good luck with your financial future.