Does your loan purpose matter? Yes — here’s how much

Your reasons for taking out a personal loan are exactly that — personal. So does your loan purpose matter? In short, yes.

While most reasons won’t stop you from obtaining a personal loan, you’ll need to explain why you need the money you’re borrowing. You can generally use the loan proceeds however you see fit, but some lenders have restrictions. Plus, the loan purpose could impact the loan terms you receive.

Why does loan purpose matter?

The lender needs to determine whether the money will be used for something they allow. Debt consolidation, making large purchases or emergency expenses are all common uses for personal loans. But some lenders have specific use restrictions. The purpose of your loan may also impact the amount, interest rate and terms you qualify for.

How loan purpose affects your loan

The purpose of your loan can impact these four factors:

• Lender choice: Some lenders only offer loans for specific purposes. For instance, Happy Money only offers loans for credit card debt consolidation. If you are also trying to consolidate other unsecured debts, like high-interest personal loans, you’d have to look for another lender.
• Loan amount: Though 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.
• Repayment term: Your loan purpose may impact the repayment terms available to you. LightStream offers longer terms of up to 12 years for home improvement loans, but up to seven years for other purposes.
• Interest rates: Many lenders determine personal loan rates based on factors like your credit score, loan amount and term, some also consider what the money will be used for when developing the rate offer for a loan. Lenders may charge a higher rate if you plan to use the loan for debt consolidation versus making a significant purchase with the money.

Common reasons for taking out a personal loan

Your loan purpose is the reason you want to borrow money. When you fill out a loan application, you might come across a section that asks why you are applying. Some lenders do this to match you with the right product. They can also use your loan purpose to assess risk and assign loan terms.

There are many reasons you may want to consider taking out a personal loan, including:

• Child-related costs: If you want to expand your family, a personal loan can cover the costs of fertility treatments, adoption expenses or hospital bills from labor and delivery. While it can also help cover needs after your child comes home, a personal loan is usually best for fixed costs.
• Debt consolidation: You can save money on interest payments by consolidating high-interest debt, like credit cards, with a personal loan with lower interest rates. The average credit card interest rate right now is around 21 percent. Personal loan interest rates average a little over 12 percent. If you have stellar credit, you could secure the lowest interest rate available, which is often much less than a credit card.
• Delinquent debt: Whether you owe a debt collector or the IRS, you can use a personal loan to pay off the outstanding balance and eliminate the added stress.
• Emergencies: If you need to pay bills right now and don’t want to be late, you can take out an emergency loan to cover those costs. If you lose your job, get your work hours reduced or have an emergency medical bill, a personal loan can meet your needs in the short term.
• Funeral and end-of-life needs: A personal loan can pay for the funeral, burial and related end-of-life costs when a loved one dies.
• Home improvements or repairs: If a water pipe bursts or your air conditioning goes out, a home improvement loan can pay for repairs if you don’t have the cash and don’t want to use your credit card.
• K-12 education expenses: If your child is enrolled in a private school, a personal loan can help cover the often-pricy tuition.
• Large purchases: You can use a personal loan to buy a recreational vehicle such as a boat, an RV or a private jet — or to improve your quality of life. You can also use a personal loan to spread out the costs of purchases that would take a significant chunk out of your budget, such as dental bills, new appliances and veterinary expenses.
• Major life milestones: If you’re planning a big move for a new job or helping a grown child pay for a wedding, you may need extra cash.
• Vehicle financing: Though it isn’t the norm, personal loans can be used to buy a car. This is especially true if you’d prefer not to use the vehicle as collateral, as you would with an auto loan.
• Vacation expenses: A regular vacation probably doesn’t warrant using a personal loan to cover the costs. But a personal loan could be worthwhile if you’re looking to cover costs for a vacation celebrating a major milestone, including a honeymoon or anniversary.

Restricted personal loan uses

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

• Down payment on a home purchased with an FHA or conventional mortgage: Lenders view this practice as risky as the likelihood of falling behind on loan payments is higher with two loan payments to manage. Although it could take some time, 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 purposes, including college tuition and fees: This results from the 2008 Higher Education Opportunity Act, which provides a series of requirements that lenders offering education loans must abide by. Many lenders fail to meet these mandates, so personal loans are often disallowed for higher education expenses. However, federal student loans could be a viable option as they come with low interest rates, and generous loan terms and are available to most students regardless of credit history.
• Business-related expenses and gambling activities: Not all lenders restrict using loan proceeds for these purposes. Still, it’s worth asking as it’s not uncommon to find that business expenses or expenses incurred as a result of gambling activities are prohibited.

When not to use a personal loan

Personal loans can be a fast, convenient way to get needed cash. However, there are instances where they aren’t the best choice. For example, you may get a far lower interest rate and better loan terms if you need funding for a car and take out an auto loan instead. This is also the case for home purchases. A 30-year mortgage will get you an extended loan term to make your monthly payments more affordable.

Consider whether you need the funds. If you’re looking to cover the cost of something you want versus an actual need, you may be better off saving up over time to make the purchase. Plus, you’ll keep more of your hard-earned money in your pocket by not having to pay interest.

Be wary of personal loans if you have fair or poor credit. Though some lenders offer bad credit loans, these tend to come with higher interest rates and fees. The lowest personal loan rates often go to those with excellent credit and solid financials.

Most importantly, run the numbers to make sure borrowing makes sense. You can do this with the help of a personal loan calculator. If the monthly payment stretches your budget too thin, it’s not worth the headache, regardless of how you intend to use the funds.

The 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 realistic idea on what you’re eligible for, without impacting your credit.

Frequently asked questions

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

  The best reason is exactly what you plan on using the loan for. Lying to your lender could lead to legal trouble.

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

  Sometimes things change from when you apply for a personal loan to when you plan 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. But before you use the funds, make sure there are no restrictions from your lender. If you’re worried about mishandling the funds, contact your lender to see if your new loan purpose is covered.