4 ways a personal loan could help you save money

Personal loans typically come with more competitive interest rates than other lending products, such as credit cards and credit card cash advances. Because of this, a personal loan with a good rate could save you money in the long run while offering similar flexibility.

You can use a personal loan to keep more money in your pocket by combining high-interest credit card debt with a low-interest debt consolidation loan, financing a large expense or even as a tool to increase your credit score to obtain more competitive interest rates in the future.

1. Consolidate credit card debt

One of the most common uses of personal loans is to consolidate high-interest credit card debt. This is partially because personal loans typically have lower average interest rates than credit cards. The average credit card currently has an interest rate of nearly 21 percent, while the average personal loan interest rate is under 13 percent.

You will need a good or excellent credit score to qualify for the lowest rates. Ideally, the interest rate on the new loan should be lower than the rate you currently have, so you spend less overall on interest.

If you don’t have time to wait until your score improves and need to tackle debt fast, you can also apply for a loan with a co-signer or co-borrower with good credit to increase your chances of getting the best rates.

How consolidating debt saves money

By consolidating credit card debt — and other debts — into a single, easy-to-manage loan with a lower interest rate, you can reduce the interest you pay each month. It may also free up some cash in your budget to pay off your debt more quickly, saving you hundreds or even thousands on interest over the life of the loan.

2. Finance a big expense

Most lenders let you use a personal loan for almost anything. The loan proceeds can cover a vacation, wedding, boat, one-time medical procedure and many other costs. That said, using the funds for higher education expenses, gambling and illegal activities is typically prohibited. 

Consider the benefits and drawbacks of financing your intended purchase with a personal loan. Determine whether it will benefit you in the long term or help improve your financial well-being, or whether the benefit will be short lived and potentially lead to payments that cause financial strain.

It’s equally important to run the numbers to determine if taking out a personal loan for this purpose makes financial sense. If you decide to move forward, use a loan calculator to determine if you can afford to comfortably repay the loan without stretching your budget thin.   

How financing a big expense saves money

Using a personal loan to finance a big expense rather than a credit card can save you money because you can potentially lock in a lower interest rate. What’s more, since personal loans are considered a cash payment, you may be able to get a better deal — depending on what you’re planning to use the money for.

3. Increase your credit score

Beyond saving money, a personal loan can boost your credit score. If you have credit card debt and spend close to your spending limit every month on your cards, your credit utilization ratio will increase.

This means lenders may consider you a higher risk, and high-risk borrowers are often given higher interest rates. Personal loans can help with credit utilization if you use the loan proceeds to consolidate credit card balances — provided you keep spending on your cards to a minimum.

If you have little or no credit history, a personal loan could also be a great tool to boost your credit. It will contribute to your credit mix and payment history, which both account for 45 percent of your credit score.

How increasing your credit score saves money

Increasing your credit score allows you to qualify for more competitive interest rates when you borrow, whether for a mortgage, car loan or any other type of loan product. When you qualify for the most competitive interest rate possible, borrowing money costs you less.

4. Avoid pesky fees

Many credit cards and personal loans come with fees, which will increase your annual percentage rate (APR). That being said, there are a variety of lenders that don’t charge any mandatory fees, including:

• Citi.
• Discover.
• LightStream.
• Navy Federal.
• SoFi.
• TD Bank.
• U.S. Bank.
• Wells Fargo.

Be aware, though, that fee-free lenders typically require excellent credit and a stable source of income for you to qualify. And while these lenders don’t charge an application or origination fee, they might still charge a late fee if you aren’t on time with your payment.

How avoiding fees saves money

Being a savvy borrower and avoiding unnecessary and unexpected fees can save you hundreds or even thousands of dollars over the life of a loan.

When should you use a personal loan?

Whether a personal loan is a good idea depends on your financial situation and goals. For example, a personal loan can be a good idea if it helps you cut down on high-interest debt by allowing you to secure a lower average rate. It may also make sense to take out a personal loan for a home improvement project that adds value to your home.

However, there are some scenarios where using a personal loan could be less ideal. A personal loan might not be your best choice if you qualify for a cheaper financial product, like a 0 percent APR credit card. You also need to be sure you can repay your loan — taking out a personal loan can put you in a bad situation if you are unable to repay it.

The credit score required for a personal loan is typically 610 to 640 or higher — if your score is below that, you may want to work on it before applying. Even if you do qualify, a score on the lower end may result in higher interest rates.

The bottom line

Personal loans can save you money in a number of ways. However, there are alternatives to personal loans that may also save you money. As with any big financial decision, consider your options carefully and shop top lenders to ensure you save as much as possible.