A consumer loan gives you flexibility and the opportunity to spend the money as you see fit. Unlike credit cards, these loans generally come with a lower interest rate and a longer down payment.
Here we take a closer look at when it is appropriate to use a consumer loan and vice versa, when it is not.
When can a consumer loan be the right form of financing?
An unsecured loan means that the debtor does not need to provide collateral for the loan. However, lenders have other ways to get your money back, so don’t be misunderstood.
These loans are more suitable for people with stable finances. In other words; people with stable incomes and a low to moderate degree of family indebtedness.
With a decent credit score, you would also be rewarded with lower interest rates. That’s because the risk of default is lower, seen from the banks’ perspective.
Unsecured loans are also prudent in cases where there are no realistic ways to guarantee the loan. For example, you would never finance your home this way (which is why we have mortgages), but you may want to use it for other purchases that cannot be guaranteed.
Unsecured loans should also be used to finance assets of lasting value. For example, to build a shed where you can work on your hobbies or a lawn mower that will last you for many years.
What should it not be used for?
Here is a short list, with some items that should not be financed with unsecured loans:
1. Fixed monthly costs: Unless we’re talking about a one-time exception (let’s say the washing machine broke), you should never use it to cover your monthly fixed costs.
If you cannot afford these expenses on a monthly basis, it is an indicator that your household budget is under great pressure. Borrowing money to pay bills will only add to the financial pressure on your home.
2. The down payment on a mortgage: You should never fund your down payment requirements with anything other than your own savings. There are several reasons for this, but the most important has to do with the financial risks you are taking.
If interest rates go up (or if you lose your income), you will have serious trouble meeting your monthly mortgage bills. An unsecured loan would only add stress to the situation.
Also, let’s not forget why banks are required to require a down payment in the first place. It is so that you have fewer financial opportunities when you sign the mortgage.
3. Interest on other loans: This may seem obvious, but it should not be ignored. Never use a consumer loan to pay interest on other loans. You are simply pushing the problem ahead, adding more fuel to the fire.
