Dear Personal Loan
I’m looking into borrowing some money using a personal loan to finance a vacation this summer. My credit is in pretty good shape, with a FICO credit score just a little below 700.
What else is the lender going to need to approve my vacation
— Vinny Vacation
Because a personal loan doesn’t have any collateral, the lender is going to want to know more about you than just your credit score. Lenders consider the 5 C’s of credit:
- Credit history.
Your credit score speaks to just 1 of these 5 C’s — your credit history.
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The lender is going to want to know more about your capacity to repay. They’ll want to verify your income and employment. They’ll also take a look at your outstanding debt level.
Increasing your debt load
When you’re using a personal loan to consolidate your debts, you’re restructuring outstanding debts, not adding to them. However, using the loan to pay for a vacation is going to increase the amount of debt you have outstanding. You need an income sufficient to service your debt load.
In a recent blog post, I spoke with Adam Hughes, the COO of Avant, a personal lender. His firm shows that less than 2% of the people applying for a personal loan indicate that they’re doing it to fund a vacation. That doesn’t make the decision to fund your summer vacation with a personal loan wrong, but you should consider the interest rate on the loan and the loan term in deciding whether this is the right choice for you.
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The loan is amortized
Let’s just say that you borrow $5,000 at 12% for the next 3 years. Your monthly loan payment will be $166.07, ignoring any fees. It’s an amortized loan, meaning that monthly payment covers both the interest expense and the repayment of the $5,000 over the loan term. You’ll pay $978.58 in interest over the 3 years. (You can use Bankrate’s loan calculator to figure the loan payment and interest expense when you know the particulars of your loan.)
The financial planner in me says this can work for a one-time situation, but consumers shouldn’t get in the habit of financing their current expenses. How are you going to finance next year’s vacation? It’s hard to save for the future when you’re paying off past spending, with interest.
Ask the adviser
To ask a question of Dr. Don, go to the “Ask the Experts” page and select one of these topics: “Personal Loans,” “Financing a home,” “Saving & Investing,” “Senior Living” or “Money.” Read more Dr. Don columns for additional personal finance advice.