How to Use a Personal Loan to Save Money

Lidia Staron, author at OpenLoans
Lidia Staron   Head of Content
Personal Finance
I enjoy navigating people through important financial decisions.

How to use a personal loan to save money.

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There are plenty of financing options available to the average consumer such as credit cards, auto loans, and home loans. But out of all of these, there's one that does more than just get you money that you need. It can help you save money, too. The type of loan we're talking about is personal loans.

What Is a Personal Loan?

A personal loan is a type of unsecured loan which means you do not have to put up collateral in exchange for borrowing money. Personal loan amounts are typically between $1,000 to $100,000. Usually, there are fixed interest rates for personal loans (typically ranging from eight percent to 11 percent) and the loan is paid back in monthly installments.

There are plenty of uses for this kind of loan. You can use it for a medical emergency or a vacation. You can get a personal loan for home improvements. You can even get a personal loan for business expenses. Unlike most other types of loans, you can use the money at your discretion which provides you with a lot of flexibility. Take note that some lenders will still require you to specify what the money will be used for in your application.

How Does a Personal Loan Save You Money?

Questions you might have about using a loan product to reduce the expenses in your life.

1. Personal Loans Ideal for Debt Consolidation

One of the best reasons is to get a personal loan to consolidate debt and save money on interest. Now, taking on more debt may seem counterintuitive to saving money. But a personal loan can help lower the amount of debt you have. How's that possible? Well, here's an example: credit cards can have an interest rate as high as 20 percent. Making your monthly minimum payments will not put a dent in your revolving debt. If you get a personal loan with a lower interest rate, you'll be able to pay off the debt faster and pay less interest in the long run.

Aside from helping you save money on interest fees, debt consolidation can also help you organize your debt. Having multiple small loans consolidated into one large loan can help simplify your payments.

2. Can Improve Your Credit Score

Your credit score is calculated based on several factors including your credit utilization ratio. This is measured by how much of your credit limit you are using. For example, if you have a credit card that has a spending limit of $5,000 and you've already used $3,000 on the card, then you have a credit utilization ratio of 60 percent. This is much higher than what lenders prefer; the optimal is 30 percent, and the maximum is 50 percent. A high credit utilization ratio makes you a higher risk to lenders. By consolidating your credit card debt to a personal loan, you lower your credit utilization ratio which can help improve your score.

Adding a personal loan to your credit mix helps you diversify the types of debt you have which, in turn, also helps improve your credit score. How does this help you save money? A higher credit score can help you get lower interest rates on future loans which means potentially saving loads of money.

3. May Help You Avoid Fees and Credit Damage

Generally speaking, you shouldn't use a loan to pay your bills. However, under certain circumstances, getting a personal loan to pay an upcoming bill is better than missing a payment altogether. Late payments come with late fees which can accumulate quickly. In addition, late payments will affect your credit since these are usually reported to credit bureaus. Based on the FICO chart, you can lose as much as 110 points on your credit score just by being 30 days late on your mortgage.

Now, if you're in danger of missing a payment, you should first try to talk to your creditor and work out some sort of payment plan that will help you stay current on your account. If you aren't able to come to an agreement, you can opt to take out a personal loan to help make your payments. Just make sure that you are able to keep up with having an additional monthly bill to pay.

4. Finance a Big, One-Time Expense

We've already mentioned that personal loans help with medical emergencies. Unfortunately, not everyone can set aside an emergency fund to cover such an expense. Now, you can always use your credit card. But we've also previously mentioned that this type of debt comes with high-interest rates which will end up costing you. Instead of going for your credit card, get a personal loan to cover your unexpected expense. The lower interest rate will translate to lower monthly installments and huge savings on interest. As an added bonus, you may get a higher loan amount with a personal loan compared to a credit card which may be necessary considering how expensive health care is these days.

5. Allows You to Pay off Your Debt Early

Personal loans come with a specified term length. If you are able to repay your personal loan before the end of the term you and the lender agreed upon, you can save hundreds or thousands of dollars in interest. Of course, this presupposes that your loan does not come with a prepayment penalty. The good news is that most personal loan lenders do not charge you a fee for paying off your debt early.

6. Helps Limit Your Overspending

There are a lot of instances in life where you'll need to make a large purchase such as home improvements, moving, a family vacation, or repairs. These are expenses that will put a huge dent in your pocket; you may not even have that amount readily available to you.

The instinctive reaction is to get your credit card and charge the expense there. However, a personal loan may be a better choice. Aside from the fact that a personal loan may save you money on interest, it will also limit you to spending a certain amount. You need to specify the amount to be used in your loan application. You may not receive additional money that you may be tempted to spend on anything else.

7. Be Responsible

As you can see, personal loans can be incredibly useful in helping you manage your finances. It can certainly help you save a lot of money that could lead you to become debt-free. However, all of that is only possible if you use these loans responsibly. Taking advantage of low-interest rates won't do you any good if you can't pay the debts back in a timely manner. 

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