What Should You Not Use a Loan To Purchase? Quick Guide

Personal loans can be a tempting way to cover expenses, but some purchases aren’t worth financing. Some of those instances include splurges, like a luxury vacation, designer goods or even a lavish wedding.

Here are some guidelines on when you may want to avoid using a loan to pay for certain items or experiences.

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Quick Take

• Avoid taking out a loan for big-ticket wedding costs or major travel expenses.

• Avoid using a loan to invest in risky investments like crypto or volatile stocks.

• Avoid borrowing money to pay for your day-to-day expenses.

• Avoid getting a loan to fund another loan.

When Is It Smart vs. Risky To Use a Personal Loan?

Not sure if a personal loan is the right choice? Here’s how to evaluate it:

Smart Uses

• Use of medical bills → Urgent, unavoidable expenses

• Car repairs → Need a car for transportation

• Home improvements → For essential needs like plumbing, heating or cooling

• High-interest debt consolidation → Save money in the long run by lowering interest rates

Do Not Use a Loan For

• A depreciating luxury asset → Value will drop before you can pay the principal

• Crypto investing or other risky investment → Risk outweighs debt

• Lavish wedding or a luxury dream vacation → You’ll be paying high-interest debt for years

• Down payment for another loan → You’ll continue to be in the debt cycle

Good To Know

If you’re planning to buy a home, check lender rules first — personal loans are usually not accepted for down payments.

What Happens If You Misuse a Personal Loan?

Misusing a personal loan can lead to serious consequences. Here’s what can happen if you fall behind on payments:

0 to 30 days: Late Payment

• You miss a payment, but your account isn’t severely overdue. You could be charged a late fee.

30 to 90 days: Delinquency

• A missed payment can be reported to the credit bureau. It could impact your credit score.

90 to 180 days: Default

• You fail to pay the loan based on the agreement, and your account can be sent to collections.

180+ days: Collections

• Your loan is charged off and sent to a third-party collector. This causes permanent damage to your credit report.

How Do You Decide If a Purchase Is Loan-Worthy?

Here’s a quick checklist to see if a purchase is worth it:

• Is it a need and not a want?

• Will it outlast the loan term?

• Can you afford the monthly true cost?

• Does it increase in value or net worth?

• Is there a cheaper alternative?

• Will there be a return on your investment?

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

• When to choose this: You have a short-term expense and can replenish the fund quickly.

• One key caveat: You don’t want to put too much into your emergency savings. It may not keep up with the rate of inflation.

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.

Payment Plans With Service Providers

• When to choose this: You want to avoid taking on new debt, and the plan offers a flexible repayment option.

• One key caveat: Read the agreement carefully because the provider plan has strict requirements on repayment of the debt.

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

• When to choose this: You can adjust your budget or increase your income, even temporarily, to cover your expenses.

• One key caveat: This approach may not address urgent needs.

Go through all of your expenses 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% Annual Percentage Rate (APR) Credit Cards

• When to choose this: Choose this option if you can pay off the debt within the period where you aren’t charged interest.

• One key caveat: If you don’t pay off the balance within the 0% interest period, a higher interest rate will kick in.

Some credit cards have introductory offers of a 0% APR on purchases or balance transfers. 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 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

• When to choose this: You’re struggling with monthly payments and cannot keep up because of financial hardship.

• One key caveat: Debt relief can significantly hurt your credit.

Debt relief services involve negotiating with creditors to lower principal balances due on debt.

You could also tap a nonprofit credit counseling agency to set up a debt management plan.

What Should You Watch Out for in Loan Agreements?

Here are some red flags you need to watch out for in a loan agreement:

• Prepayment penalty: Make sure there isn’t a penalty to pay off your loan early.

• Fixed rate: Check that your interest rate is fixed and not a variable rate.

• Origination fee: This fee can lessen the amount of your loan.

• Total cost of loan: Look to see if there’s an estimated total cost of your loan in your agreement.

• Payment schedule: Make sure there’s a clear payment schedule with the monthly amount and due dates.

Keep In Mind

If you’re comparing the best banks and lenders, take the time to review rates and terms to find the most competitive offer before applying.

Key Takeaways

• You should get a loan to address pressing financial needs, not discretionary spending.

• If you get a personal loan for restricted purposes, you’re in breach of your contract.

• Missing a loan payment can cause interest and fees to accumulate and damage your credit score. If you default multiple times, your account could be sent to collections.

• Double-check your loan agreement for a prepayment penalty, origination fee and whether your interest rate is variable or fixed.

Terms To Know

• Prepayment penalty: This is a fee charged by the lender if you choose to pay off your contract early.

• Origination fee: This is an administrative fee that is deducted from the loan amount. It typically is 1% to 8% and lessens the amount of money you receive.

• Variable rate: If the interest rate is variable, it can change as time goes on and can impact how much you pay on your loan.

• Acceleration clause: If you default on payments, the lender can accelerate the loan. The lender can demand that the remaining balance be paid immediately.

FAQs

Can you use a personal loan for anything?

You can get a personal loan for nearly anything. However, you cannot get a personal loan for illegal activities, investments or student loans.

Is it OK to use a loan to pay bills?

Yes, but only temporarily since you’re adding a new bill to your monthly charges.

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

Using a loan for gambling or a risky investment, since you’ll likely be incurring more debts.

Can you use a loan for a down payment?

Lenders typically won’t let you use a personal loan for a down payment on a house.

Can you get in trouble for using a loan incorrectly?

You usually will get into financial trouble because the lender can accelerate the debt. Your entire loan will come due.

Will lenders check how you use the loan?

Indirectly, they may be able to check how you use the loan.

Jeanine Skowronski contributed to the reporting for this article.

Photo credit: LSOphoto / iStock.com