What Should You Not Use a Loan To Purchase?

Personal loans provide funds to cover some expenses, but there are occasions where you shouldn't use them. For instance, some financial institutions won't allow you to use personal loans for college tuition, student loan debt or business expenses. Plus, most mortgage lenders won't let you use borrowed funds for a down payment.

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Broadly speaking, however, you should avoid using a personal loan for any purchase that won't improve your financial situation or will likely result in an outstanding balance you can't afford.

When Should You Use a Personal Loan?

Keep in mind that just because you can use a personal loan for most purchases doesn't mean you should. Personal loans aren't free. According to the Federal Reserve Bank of St. Louis, they carry an average annual percentage rate (APR) of 11.66%.

Given the cost of financing and the consequences of default, you're best off using personal loans to address pressing financial needs, like medical bills, emergency car repairs, home improvements, or high-interest debt consolidation. You're best off avoiding them for discretionary spending or splurges, such as a luxury vacation, a designer handbag or a lavish wedding.

"Someone considering a personal loan should not have other significant debt and make sure repayment fits into the household budget," said Kyle Enright, president of lending at Achieve.

Best and Worst Ways To Spend Loan Money

Remember, not all lenders apply the same restrictions to personal loans. However, this chart breaks down their commonly accepted, restricted or risky uses.

👉 Can You Use a Personal Loan to Buy a House?

What Happens When You Use a Loan Incorrectly?

Misusing a personal loan can have significant consequences. For starters, if you use the money to pay for a prohibited product or service, you'll breach your loan contract. That'll potentially allow the lender to demand immediate repayment of all funds.

There are also serious consequences when misuse correlates to your inability to repay.

Interest and Fees Accumulate

Missed personal loan payments are expensive. They typically result in late fees between $25 and $50 or 3% to 5% of your monthly payment, and you can get hit with other charges, like non-sufficient funds fees (NSFs).

Plus, interest will continue to accumulate, even if the lender agrees to deferment or forbearance.

Missed Payments Damage Your Credit Score

Once a missed payment is 30 days past due, your lender is likely to report the delinquency to the credit bureaus. A single missed payment can do considerable damage to your credit score, given payment history is the biggest factor in determining your score. From there, the effects can compound until the loan is current.

You Could Face Debt Collection Efforts or Legal Action

Once your loan is over 90 to 180 days past due, lenders may take more serious action to collect the outstanding balance. For instance, they may sell the debt to a debt collection agency, resulting in further damage to your credit.

The lender or the debt collector also could sue to secure a judgment against you and garnish your wages or bank account.

You Could Get Stuck in a Debt Cycle

Getting in the habit of borrowing from Peter to pay Paul is likely only to add onto your financial struggles, as affordable financing gets harder to qualify for and interest accumulates across multiple outstanding balances.

How To Decide If a Purchase Is Loan-Worthy

If you're on the fence about a personal loan, start by determining whether the purchase is a want or a need.

"If you live in Montana and your furnace goes out in the winter, for example, that's a true need," Enright said. "If you spot a good price on a new washer and dryer while your current ones are still working, that's likely a want."

Better Alternatives To Taking Out a Loan

Personal loans aren't always your best financing tool. Consider these alternatives before taking on the debt.

Emergency Savings

"Avoiding debt altogether is always the best option," Enright said.

Building up your emergency savings can help you stay out of debt. Put away one-to-six months' worth of expenses by opening a high-yield savings account, establishing automatic deposits and banking windfalls. When you have to dip into your emergency savings, make sure to replenish it.

Payment Plans with Service Providers

If you're having trouble with household bills, try contacting your provider, servicer or lender. Many companies are willing to extend due dates, negotiate lower rates or balances and waive fees for customers experiencing financial hardship.

Budget Cuts or Side Gigs

Go through all of your expenses that aren't necessary and see where you can make cuts. Common expense cutbacks include streaming services, meal delivery and gym memberships. You can also look for side jobs to help you earn more money.

0% APR Credit Cards

Some credit cards have introductory offers of a 0% APR on purchases or balance transfers. Some of the best offers last up to 24 months. With these cards, you can save more on interest than a personal loan if you can qualify and pay the balance off before the introductory APR period ends.

After that, the outstanding balance accrues the go-to variable APR, which is often higher than the APR on personal loans.

Debt Relief Services

"​​If you are in a situation where you're having a hard time with minimum payments on current debt, you likely won't find much help by taking out a personal loan and adding even more debt," Enright said. "You may need to evaluate other alternatives, such as debt settlement, which involves negotiating with creditors to lower principal balances due on debt."

You could also tap a non-profit credit counseling agency to set up a debt management plan.

FAQs

Can you use a personal loan for anything?

You can use a personal loan for most purchases, as long as they're legal. Many lenders impose use-case restrictions. For instance, you often can't use a personal loan for college tuition, student loan debt, down payments or gambling.

Is it OK to use a personal loan to pay bills?

You can use a personal loan to catch up on bills. However, it's generally not recommended if you have a steady income or can qualify for more affordable financing options, like a 0% APR credit card or service provider repayment plan. Carefully consider all alternatives, including credit counseling, if you find yourself unable to pay for basic bills and living expenses.

What's the worst thing to use a loan for?

You should avoid using a personal loan for any purchase expressly forbidden in your loan agreement as that can result in steep penalties and, in extreme cases, legal charges. You should also avoid using a personal loan to pay off other debts unless you have a well-thought-out repayment plan in place.

Will lenders ask what I'm using the loan for?

Most lenders will require you to specify a personal loan's purpose on your loan application. What you can — or cannot — use the personal loan for is generally included in your loan agreement.

Can I get in trouble for using a loan the wrong way?

Yes, you can run into trouble if you misuse a loan. Violating a loan agreement may trigger fees and acceleration clauses, which may require immediate repayment of any outstanding funds.

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