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Conventional wisdom has it that while loans are a successful financial tool, they don’t cut your overall household debt, and that a personal loan adds to that debt.
New thinking, however, touts the ability of personal loans to not only solve quick money problems, but save borrowers money, too.
“Personal loans can be very helpful to some consumers who are committed to paying off debt,” said Joseph Toms, president of Freedom Financial Asset Management (www.freedomplus.com) in San Mateo, Calif. ‘They can also be helpful in other ways.”
For instance, a personal loans can help someone who has other higher-interest unsecured debt and would benefit from a lower rate.
Or, a personal loans can help someone save money who sticks to the strict loan payment schedules, or someone whose credit scores alone do not reflect their capabilities to repay such a loan.“Simply stated, personal loans are not intended for someone looking to simply “shift” debt from one vehicle to another,” Toms said.
How a Personal Loan Helps Save Money
In everyday life, personal loans offer savings that some financial consumers don’t realize they’re getting.
These savings features are some of the best examples.
Interest rate savings.
A personal loan generally offers a lower interest than many credit cards, and there’s good savings in that scenario. In fact, it may even be able to cut credit card interest rate debt by 50%.
“For example, credit cards can carry interest rates of 15-25%,” Toms said. “Average rates on personal loans are 14%-to-18%. They can vary widely, however, from just over 4% annually (for people with exceptional credit) to 25% for people with poor credit. Credit scores play the key role in setting the rate.”
Toms lays the savings potential of lower interest rates out in this example.
“For example, if you repaid $15,000 over 60 months at 18% (such as on a credit card), you would pay $381 per month,” he said. “The interest would total $7,851. If you could lower the interest rate to 14% with a personal loan, over the same 60-month period, you would pay $349 a month and total interest of $5,942 – a savings of $1,909.”
It frees up money sooner.
Personal loans usually come with strict payment schedules and terms of 36 to 60 months.
“Because you don’t have the option to make only minimum payments, as you would on a credit card (and therefore potentially take many years to pay off the debt), you must keep to the timeline to pay off the debt,” Toms added. “That means the money that went to servicing the debt soon becomes available for saving, investing and other uses.”
Quick access to money.
A personal loan can also help you save if you need to make a big purchase and don’t have time to save – especially if that item is available for a limited time at a steep discount.
“For example, if you recently moved and need to furnish an apartment, using a personal loan is less expensive than using a credit card,” said Anna Serio, a certified commercial loan officer with Finder.com. “If you can save but want to take advantage of a big sale, use a personal loan calculator to make sure the savings are worth more than what you would pay in interest.”
By increasing your property value.
Another scenario where a personal loan can help is to make home improvements that will increase your property value, such as using a low-interest personal loan to build an addition or renovate a kitchen.
Other loans also offer savings on home improvement projects.
“However, many people choose to get a home equity loan or line of credit for this purpose instead,” Serio added. “That’s because home equity loans use your home as collateral may help you qualify for a lower rate.”
Don’t use up all the loan money
– and save money doing so. “In my opinion, a personal loan is generally a great way to get financial aid and relief,” said Jeremiah E. Heck, a debt and bankruptcy attorney at Ohio-based Luftman, Heck & Associates. “However, it’s best to proceed with caution when obtaining one because it can make a situation worse if used for more frivolous reasons.”
“This is especially true when it comes to opening a credit card account,” Heck added. “There are very few times that you would want to take credit card or medical debt, which is unsecured, and turn it into a secured debt through an equity line of credit or otherwise.”
If you do secure a loan, Heck advises paying for the immediate emergency you may have, or if you can, but saving 20% of it for future emergencies, and then paying off other small debts you may own.
“That way you’ve (1) saved for a rainy day, (2) improved your credit utilization score, and (3) decreased your payments to one a month,” Heck said.
“I say this because personal loans typically help you handle unexpected expenses like an emergency room visit, or replacing an HVAC unit in your home,” he added. “In either case, the personal loan allows you to cover the costs of the large expense immediately and then create a ‘payment plan’ that works better for you.”