Does your loan purpose matter? Yes — here’s why

When taking out a personal loan, there are many reasons why loan purpose matters. While most won’t stop you from obtaining a personal loan, you’ll need to explain the loan purpose, or why you need the money you’re borrowing.

You can generally use loan proceeds however you see fit, but some lenders have restrictions. Plus, the loan purpose could impact the terms you receive. Before you take out a personal loan, it helps to know why loan purpose matters, and why you should be honest about your intended use.

Why does loan purpose matter?

Debt consolidation, emergency expenses and vehicle financing are all common uses for personal loans. Whatever the reason you might be looking into a personal loan, many lenders request the purpose for a personal loan from borrowers before giving approval.

The loan purpose matters because the lender needs to determine whether the money will be used for something it allows. Some lenders may have specific restrictions as to what funds can be used for. The purpose of your loan may also impact the amount, interest rate and terms you qualify for.

Lender choice

Some lenders only offer loans for specific purposes. For instance, Happy Money only offers loans for credit card debt consolidation. This can be a problem if you are trying to consolidate other unsecured debts, like high-interest personal loans. In this case, you would have to look for another lender.

Loan amount

Just because you provide a loan purpose doesn’t mean you will receive an open-ended loan. While some lenders like LightStream offer loans of up to $100,000, these are typically reserved for large purchases or home improvement projects.

If you need a loan to pay for a vacation, it’s likely that you won’t get approved for the lender’s maximum amount — even with excellent credit. Before taking out a loan, consider whether you are really using the best reason for personal loan approval with the terms — and loan amount — you want.

Repayment term

When taking out a personal loan, it is critical to determine the repayment term as this can affect the cost of your monthly payments. The loan purpose may impact the repayment terms available. For example, LightStream offers longer terms of up to 12 years for home improvement loans but up to seven years for other purposes. Before accepting a loan, be sure to review the repayment term and ensure you can afford the monthly payments.

Interest rates

When comparing lenders, you will quickly find that interest rates can vary significantly for a loan. Many lenders determine personal loan rates based on factors like credit score, loan amount and term. However, some lenders will also consider the purpose of loans when developing the rate offer. Lenders may charge a higher rate if you plan to use the loan for debt consolidation versus making a significant purchase with the money.

What can I use a personal loan for?

There are many reasons to get a personal loan. Debt consolidation is often the best reason for personal loan approval because you can save money on interest payments by consolidating high-interest debt, like credit cards, with a personal loan with lower interest rates. If you have stellar credit, you could secure the lowest interest rate available, which is often much less than a credit card.

Other common uses for a personal loan include covering emergency expenses, including car repairs and surprise medical bills. Personal loans can also help pay for major home improvements or repairs, as well as larger purchases like an RV or boat.

Restricted personal loan uses

Most lenders allow you to use the loan proceeds however you see fit. If the lender does impose usage restrictions, they are likely to fall into one of these categories:

• Down payment on a home using an FHA or conventional mortgage: This is risky, as the likelihood of falling behind on loan payments is higher with two payments to manage. Saving up over time in a high-yield savings account is a better alternative to come up with a down payment for a new home.
• Educational expenses and tuition: The 2008 Higher Education Opportunity Act restricts what education loans can be dispersed by lenders, so personal loans for college are often disallowed. Federal student loans could be a viable option with their low interest rates, generous loan terms and wide availability, regardless of credit history.
• Business-related expenses and gambling: Not all lenders restrict the use of loan proceeds for these purposes. For many lenders, however, business expenses or expenses incurred as a result of gambling activities are prohibited.

Bottom line

Your reason for getting a personal loan is yours, but your potential lender can determine important loan factors based on that reasoning. Regardless of why you need a personal loan, compare lenders to see which offers the best personal loan rates based on your credit and needs. If possible, try comparing offers from lenders offering prequalification, as this will give you a realistic idea of your eligibility without impacting your credit.

Frequently asked questions

• What is the best reason to give when applying for a personal loan?

  The best reason for personal loan approval is the truth. Lying to your lender could lead to legal trouble.

• What happens if I use my loan for a different purpose?

  Circumstances and needs can sometimes change from when you apply for a personal loan to when you are ready to use the funds. Say you took out the money to pay for a child’s wedding, but the wedding got postponed or canceled. You could use the funds for other needs, like paying down debt or funding other ventures, like a vacation. Before you use the funds, make sure there are no restrictions from your lender.

• Does loan purpose affect approval odds?

  The purpose of loans can affect not just the terms of your loan but also whether you are approved at all. Some lenders may restrict the loan amount or repayment term based on how you plan to use the funds, others may disallow certain uses entirely. It can also affect your interest rate, which affects how much you pay over the life of the loan.