5 ways a personal loan could help you save money
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Personal loans can be used to cover a variety of life’s expenses and because they typically come with more competitive interest rates than other forms of borrowing they often save you money.
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 consolidate high-interest credit card debt. Plus, using one could 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.
Below are five ways a personal loan could help you save money:
1. Consolidate credit card debt
If you’re struggling to make the minimum payments on your credit cards, a personal loan with a lower interest rate may be the best option to help you save money and pay off your debt. Some lenders even have personal loans designed for that specific purpose.
Personal loans typically have lower average interest rates than credit cards, meaning you’ll spend less out of pocket on interest charges as you work to repay the debt. For example, as of September 21, 2022, the average credit card interest rate was 18.16 percent, while the interest rate on the average personal loan as of December 14, 2022, was as low as 10.72 percent.
To improve your chances of qualifying for a lower rate on a personal loan, focus on improving your credit score. Two ways to do this are to pay down your debt and make sure you pay your bills on time. If you don’t have time to wait until your score improves, try applying for a loan with a co-signer or co-borrower with better credit.
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 one-time big expense
When big moments happen in life and you find yourself needing cash for a large one-time expense, a personal loan rather than a credit card may be the most practical and inexpensive way to borrow money for that item or experience. Personal loans usually offer a more competitive interest rate than credit cards, which means you will pay less overall to finance the debt.
Because lenders typically allow you to use a personal loan for almost anything, it can be used to pay for a vacation, wedding, boat or one-time medical procedure. 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. Using a loan calculator may help.
Why this saves money: Using a loan for large, one-time expenses rather than a credit card often provides a more competitive interest rate so that financing the debt costs less overall.
3. Ditch high interest rates
A good strategy to ditch high interest rates sooner could be taking out a debt consolidation loan to consolidate multiple debts. 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 stepper 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.
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
If you’re shopping for a personal loan, review each lender’s fees and conditions to make sure you select the least expensive lender for your needs. Some lenders charge late payment fees, prepayment penalties and more with personal loans. You’ll want to read the fine print to avoid signing onto an expensive loan that includes various fees.
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
Using a personal loan to refinance credit card debt can save you a ton of money if you secure a lower rate. In addition, using one can help you save on your dream wedding or vacation if you choose a loan amount you can comfortably repay.
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.