What should you not use a loan to purchase? Many people make certain financial decisions that will affect their finances sooner or later. Loans are best used to create a new source of income that will generate profit or generate more money. However, most Nigerians jeopardize their financial security by applying for spending loans. Some take out big loans to finance a party, buy “aso ebi,” or even buy things that aren’t urgently needed.
A personal loan is a flexible loan that you can use for almost any legal purpose. Whether you want to pay off an unexpected medical bill, consolidate high-interest debt, or finance a home improvement project, a personal loan can help you achieve your goals.
What Should You Not Use A Loan To Purchase?
While a personal loan can be a versatile way to finance purchases, there are expenses that you should not finance with a loan. Here are seven things you shouldn’t use to buy a personal loan.
1. Payment of tuition fees
Paying school fees is one what should you not use a loan to purchase. Before covering your tuition with a personal loan, exhaust all funding options through federal grants, grants, and student loans. Federal student loans are generally a better option than personal loans because:
Federal student loans generally have lower interest rates than personal loans. Currently, undergraduate students can take out a federal student loan at a fixed interest rate of 4.99%, while the average interest rate on a 24-month personal loan was 9.41% in the first quarter of 2022, according to the Federal Reserve.
You don’t need a credit check for most federal student loans. The only federal student loans that require a credit check are PLUS loans, which are designed for graduate or professional students and parents taking out student loans for their dependents.
Depending on your financial needs, you may qualify for a subsidized loan. In that case, the U.S. Department of Education will cover your interest costs while you are in school for at least half of the school year, during the six-month grace period after leaving school, and during any loan deferral period.
You may receive additional benefits. Federal student loans provide access to student loan forgiveness programs and income-based repayment plans (IDRs). If you are experiencing short-term financial difficulties, you may qualify for deferral and forbearance options, which some, but not all, private student loan lenders also offer.
Once you’ve exhausted your federal student loans, you may want to consider a private (non-federal) student loan to cover a funding gap for your education. You can usually apply for private student loans through a bank, credit union, government agency, or school.
In general, investing is not the purpose of a personal loan. Even though you can generate a significant return on your investment, the interest rates you have to pay will reduce or even negate your returns. And the more you pay off the loan, the more interest you pay – something to consider, as personal loans generally have a repayment term of one to five years. So, investing is one of what should you not use a loan to purchase.
What do you do if your income changes, the market performs poorly or some other unpleasant circumstance arises? It is wise in these cases to have a backup plan to cover loan payments or even wiser to avoid taking out a personal loan for investment purposes.
Loans should not be used to fund gambling activities or speculative investments, such as stocks, cryptocurrency, or other high-risk ventures. These activities are unpredictable and carry a high level of risk, which could result in a significant financial loss.
3. Make a down payment on a house
Most mortgage lenders prohibit using a personal loan for a down payment, and this may not be possible regardless of the lender’s rules. This is because taking out a personal loan can increase your debt-to-income ratio (DTI). As the name implies, DTI is the amount of monthly recurring debt you have about your income.
Typically, when mortgage lenders review your loan application, they find your DTI ratio to be less than 43%, and some prefer that figure to be less than 36%. Taking out a personal loan can cause your DTI to exceed or even exceed the limit desired by the lender, resulting in your mortgage application being rejected.
Also, taking on new debt in the form of a personal loan can be a red flag to the lender that you don’t have the financial standing to buy a home.
4. Start a business
You can qualify for a personal loan — from a few hundred dollars to $100,000 — to start your business, but it may not be the best idea.
Unfortunately, personal loans don’t help you build business credit. Instead, your creditor reports your payments to the credit bureaus on your behalf (not your company name). If you default on the loan, your lender may try to charge you personally and possibly sue you.
If your goal is to get a business credit so that you can apply for a business loan in the future, consider getting a business credit card. With good credit, you may qualify for a 0% APR introductory offer, which gives you a period to pay off your purchases without interest. However, remember that once the introductory APR period ends, interest returns to the standard rate, which can be 20% or more.
5. Cover basic living expenses
What should you not use a loan to purchase? Is a personal loan a good idea if you are short on cash and have bills to pay? Normally not.
Indeed, a personal loan can be a viable option to help you deal with a temporary hardship if you have a solid plan to recover financially and pay off the loan. But in the long run, you could create a bigger problem because you have to pay back all the money you borrowed plus interest.
If your income is generally not enough to cover the bills, it may be time to rethink your budget. Look for areas where you can cut costs, such as cooking more at home, using coupons, or canceling unused subscriptions. Also, try to identify opportunities to increase your income. For example, you can ask for a raise at work, offer overtime, or start a side job.
These measures may not be attractive, but breaking the debt cycle is worth it.
6. Non-Essential Home Improvements:
While it can be tempting to use a loan to make home improvements, it’s important to make sure the upgrades are necessary and add value to the home. Improvements that are purely cosmetic or do not generate returns, such as a swimming pool or a home theater system, should not be financed with a loan.
7. Debt Consolidation For Non-Major Debts:
Debt consolidation can be an effective way to reduce your overall debt load and reduce interest rates. However, it is important to avoid consolidating non-essential debt, such as credit card debt used for luxury purchases or vacations. This will only perpetuate the debt cycle and make it more difficult to get out of debt in the long run.
8. Consumable goods:
Using a loan to purchase consumable goods, such as food, alcohol, or other disposable items, is not a wise use of funds. These items are meant to be consumed or used up quickly and do not provide long-term value or investment potential.
What Can I Use A Personal Loan For?
We have seen some examples where a personal loan may not be the best option. On the other hand, here are some common reasons to take out a personal loan:
- High-interest debt consolidation: If you have multiple high-interest credit accounts, a personal loan can help you combine all of those debts into one loan, with a single payment, usually with a lower interest rate.
- Paying emergency medical bills: For a significant medical bill, you may have to pay your entire annual deductible at once, even if you have excellent health insurance. Personal loans can be a cost-effective way to manage a high medical bill, but first, see if your doctor can offer you a payment plan. Some can do this without charging interest.
- Financing Home Improvement Projects: A home loan or home equity loan (HELOC) are options worth considering if you’re looking for cash to pay for home repairs or a major renovation. However, if you’re not comfortable using your home as collateral — as these loans require — a personal loan can provide you with the money you need.
- Paying for your wedding: If you still haven’t saved enough money to afford your dream wedding, a personal loan can help you fill in the gaps. This is usually a better choice than credit cards because you get a lower interest rate, saving you money in the long run.
Make Sure Your Credit Is In Order Before You Apply For A Personal Loan
If you are considering applying for a personal loan, it is important to first check that your credit is in good standing. Your credit score is a critical factor that lenders consider when deciding whether to approve your loan application and what interest rate to offer. Here are some steps you can take to get your credit in order before applying for a personal loan.
- Check your credit report: The first step to getting your credit in order is to check your credit report for errors. You can get a free copy of your credit report once a year from any of the three major credit bureaus. Carefully review your report and dispute any errors you find.
- Pay Off Debt: Your credit utilization is an important factor in your credit score. It is the amount of credit you use compared to the total credit available to you. Paying off your debt can lower your credit utilization and improve your credit score.
- Pay on time: Your payment history is the most important factor in your credit score. Late payments can hurt your credit score, so make sure you pay your bills on time.
- Avoid New Credit Applications: Applying for new credit can hurt your credit score in the short term. If you plan to apply for a personal loan, avoid applying for new credit in the months leading up to your loan application.
- Research: Finally, when you are ready to apply for a personal loan, make sure you research and compare offers from different lenders. Different lenders have different criteria for approving loans and different interest rates, so it’s important to find the best offer for your needs.
In short, taking steps to get your credit in order before applying for a personal loan can help you get approved for a loan with a lower interest rate. Check your credit report for errors, pay off debts, pay on time, avoid reapplying for credit, and look for the best loan offer. By following these tips, you can increase your chances of getting approved for a personal loan and save money on interest.
Conclusion – What Should You Not Use A Loan To Purchase?
What should you not use a loan to purchase? In short, personal loans can be a useful tool to finance major purchases, but they must be used wisely. Do not use loans for non-essential purchases, speculative investments, or debt consolidation for non-essential debts. By being mindful of your spending and using loans responsibly, you can achieve your financial goals and maintain your financial health.