Do you whip out your credit card to take care of every large purchase? Maybe you shouldn't. A personal loan may be a better alternative – but when would it be best for you?
A recent finder.com survey explored the reasons why just over one-third (34%) of Americans took out a personal loan in the last year. Says Jon Brodsky, finder's Money Expert, "With roughly 34% of Americans claiming to have taken out a personal loan in the past year, it's important to have a clear understanding of when a personal loan is the right fit for you financially."
Vehicle expenses led the field, taken out by 31% of personal loan recipients. Since most Americans need a car and few can pay with cash, it's not surprising that auto-related loans top the list. However, it is surprising that over one-quarter of Americans (26%) took out personal loans to pay bills – the second highest personal loan category. If you have to take out a loan to deal with regular monthly expenses, you need to revisit your budget (or create one if you don't already have one).
The remaining three of the top five reasons for personal loans over the past year were emergency expenses (21%), tuition fees (19%), and debt consolidation (15%).
Warns Brodsky, "Taking on debt is a major financial decision. If not managed properly, it can damage your credit score, affect home ownership opportunities and even work its way into your dating life. Try to avoid personal loans for material items or things that add no immediate value for you. When using a personal loan to cover emergency expenses, tuition or unexpected bills, develop a clear roadmap that aligns with your budget of how you will repay this debt."
Why not use a credit card for bills, emergency spending, or tuition fees? Large credit card charges rack up plenty of rewards points – but if you can't pay off balances at the end of each month, you'll also rack up interest charges that swamp your rewards.
Credit card debt is the highest interest debt that most consumers have, with an average APR of just over 17.5% across all cards. With good credit, you may qualify for a personal loan that's well below your credit card rate – possibly with interest rates in the single digits. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.
According to the survey, more men than women take advantage of personal loans (36% to 33%), but the reasons vary in insightful ways. Women take out more loans for basic needs such as monthly bills, vehicle expenses, rent, and tuition fees. Men tend to take out loans for debt consolidation, home renovations, business, medical expenses, vacations, or moving expenses.
Generally, couples borrow almost exactly twice as much on average as divorced Americans ($8,468 to $4,111). However, single Americans who never married have loan averages of $7,204, nearer to that of couples.
The higher loan balance of singles could reflect a higher proportion of young singles just starting out on their own – except that members of Generation X with personal loan debt have higher average loan balances than other generations. Gen Xers have an average $8,592 loan amount, compared to $7,703 for Baby Boomers and $7,046 for Millennials.
Where do most personal loan borrowers live? The three states with the highest proportion of residents carrying personal loan debt are Florida (43%), Texas (39%), and California (34%) – although thanks to high costs of living, the average Californian's loan balance of $11,883 is more than twice the average $5,327 loan balance of Texans and $5,317 loan of Floridians.
Take a few moments and consider the best way to finance your larger purchases. If you can pay off a purchase quickly without stretching your funds too thin, a credit card may be a better choice. For more manageable and consistent payments with lower interest rates, a personal loan may be a safer bet. You'll also retain the cushion of an available credit card balance in case of dire emergency.
There's also a third option to consider. How about saving every month to build up an emergency fund so you don't need to finance purchases at all? Consider the power of cash, as well as a budget that allows you to spend less than you make.
Counsels Brodsky, "Personal loans can be a good option when building credit or consolidating debt. But before you take on a loan, thoroughly research and compare all your options. Everyone has their own unique financial situation, and not all lenders will be a great match. Investing time in your personal finance decisions will be some of the best time you ever spend."
If you are interested in a personal loan, visit our curated list of top lenders.