Personal loans are an effective solution for consolidating debts and meeting large expenses such as home renovation projects. With fast funding, these loans enable you to qualify for lower interest rates. They are paid down in fixed instalments over an extended duration.
What are personal loans?
Personal loans are unsecured loans, meaning they are not subject to collateral. As no personal assets are secured against these loans, there is no risk of losing your assets. However, you will still face consequences for abdicating responsibility.
- You will lose your credit score.
- Late payment fees will be added, which will accrue your debt.
- Collection agencies will start chasing for payments.
- You might be sued.
All small loans, including those that you take out to meet small emergencies, are called unsecured loans, but personal loans have a separate identity from emergency loans because of their unique features.
They let you borrow a large amount of money. The minimum borrowing amount is €5,000. Unlike small emergency loans, you pay down personal loans over a period of months. Every month, you pay down a fixed sum of money until the whole debt is settled.
However, personal loans cannot be used for all types of expenses.
Things you cannot use a personal loan for
Unsecured personal loans in Ireland cannot be used for all types of expenses. You should never use these loans for the following expenses:
Investing
Personal loans cannot be used for investing. Experts do not enjoin that you employ these loans for investing. While you might be able to generate some return on your investment, the risk is too high. There is never a guarantee that you will be able to make profits on your investments.
If you borrow money to invest in stocks, for example, and you lose it, you will not only bear the loss of the money you borrowed but also the interest as well. Even if you manage to make profits on your investment, the interest you will pay over a period of time will negate returns.
Investing money using personal loans will cost you a lot more. Interest in comparison to returns is going to be quite high in total. So, you will never be able to grow your wealth in this way. You should never use an unsecured loan to invest money.
Using it for a down payment
You all know that you will need a down payment to purchase your house and a car. The minimum deposit size should be at least 10%. In case of a poor credit rating, you might have to arrange double the amount.
Many people who struggle to have enough money for the down payment often try to fill the gap using a personal loan. Experts advise against that because of the following reasons:
- This will increase the debt-to-income ratio.
- The amount of total debt will become very high. It might be difficult to keep up with payments.
If you use a personal loan for a down payment, you will most likely face difficulty getting approval for a mortgage or an auto loan. Mortgage lenders typically require you to have a lower debt-to-income ratio. It should be less than 40%. Some might prefer less than 35%.
Using a personal loan for a deposit also ensures that you are not good at money management. It will raise concerns about your repayment capacity. Lenders will never be able to believe in your potential and, therefore, will most likely repudiate your application.
Starting a business
Personal loans cannot be used for starting a business. Bear in mind that a lender would ask you for a reason for borrowing money. These loans could be used only for personal reasons, such as home improvement and buying a big-ticket item.
If you somehow use your personal loan for starting a business, it will never work to your advantage.
- Bear in mind that unsecured loans cannot help build your business credit as your lender will report payments to credit reference agencies in your name, not in your business’s name.
- If you fail to discharge your debt on time, your lender will collect money from you, not your business.
If you want to borrow money to start a business, you should use a business loan. This will not only help increase your chances of being qualified. Further, you will be able to build business credit, which is essential for future borrowing. Having built a business credit rating, you can easily apply for a business credit card or line of credit.
To cover recurring living expenses
There are some people who take out personal loans in order to cover basic living expenses. This is the worst way, as this will ruin your expenses. A golden rule of thumb says that you should use personal loans only to cover one-off costs. Rent, groceries and commute are recurring expenses. If you borrow money to pay for them, even if you are strapped for cash or have been made redundant, you will find yourself caught in an ongoing cycle of borrowing.
Personal loans should be employed to address temporary hardships. For instance, you have to see your dentist or your car is acting up. However, you should still ensure that you will not struggle with payments. If your income is not sufficient to cover bills, you should consider evaluating your budget. Figure out if you are overspending. Maybe you need to increase your income.
Vacation
You should never use unsecured loans to plan a vacation because this will undoubtedly increase your debt. Do not forget that your credit card shopping will go side by side. Convenience often results in overspending.
It will also raise your debt-to-income ratio. This will affect your creditworthiness in case you tend to borrow money for emergencies down the track.
The bottom line
Personal loans should be used for personal expenses which are one-off and unexpected. You should never use these loans for investing, a down payment, starting a business, a vacation, or covering recurring living expenses.
