Taking on debt isn’t always a bad thing. In fact, some strategic borrowing could help you build wealth, as long as you have a clear purpose for the funds.
When used wisely, debt such as a personal loan can be an effective tool for growing your income, improving your credit, consolidating debt, or increasing the value of your home. Using a personal loan for a vacation or other discretionary expense, however, won’t improve your long-term financial picture.
Knowing how to use a personal loan strategically can help you achieve your financial goals while avoiding the pitfalls of burdensome debt.
Taking on debt to make more money may seem counterintuitive, but personal loans can be useful tools for building financial security. The key is to use the loan for a specific goal that offers a return on investment (ROI), such as consolidating high-interest debt or increasing your home’s value with renovations.
Using a personal loan to consolidate high-interest debt could save you money on interest and get you out of debt faster.
Lower your interest rate: Personal loan rates are typically lower than credit card rates. According to the Federal Reserve, the average interest rate on a two-year personal loan is 11.14%, while the average rate on a credit card is nearly double that at 21.39%. Reducing your rate can save you money and potentially help you pay the debt off faster.
Simplify repayment: After consolidating, you’ll have just one monthly payment to manage, rather than juggling multiple due dates and payments. Personal loans typically have fixed rates and repayment terms, so your monthly payments are predictable and won’t fluctuate over time.
Reduce your credit utilization: If you use a personal loan to consolidate credit card debt, you’ll reduce your credit utilization, which could boost your credit score. This can make it easier to qualify for good rates and terms on a loan in the future.
Remove the temptation to keep borrowing: A personal loan offers a lump sum up front. Since it’s not a revolving line of credit, you won’t be able to continually borrow against it and incur additional debt.
If debt consolidation helps you pay off your debt faster, you’ll have more money to save for retirement, funnel into investments, or put toward another long-term goal.
Paying for home improvements is another common use for a personal loan. Refurbishing your home can increase its value, potentially leading to a higher sale price or rental income. It can also increase your equity, which could make it easier to borrow a home equity loan or HELOC in the future.
You can put a personal loan toward a variety of projects, such as replacing an old roof or adding energy-efficient upgrades that reduce your utility costs. Renovations that can add the most value to your home include renovating a kitchen, remodeling bathrooms, and sprucing up the curb appeal.
You may also use a personal loan to cover the costs of job training, such as one-on-one coaching or a certification program. Gaining new skills can lead to a higher income if it helps you secure a promotion, land a new job, or attract new clients.
Developing your expertise through professional training or business coaching can offer a high return on investment over time. This ROI may outweigh the interest you pay on a personal loan. Keep in mind, however, that most lenders don’t let you use personal loan funds for college tuition.
If the lender allows it, you might also use a personal loan to start or expand your business or side hustle. You could use the funds to pay for startup expenses, create new products, or grow your team.
Leveraging a personal loan in this way could grow your wealth if it helps your business succeed. Keep in mind that not all lenders let you use personal loans for business expenses. You should consider small business loans to determine which type of loan better suits your needs.
Taking on a personal loan isn’t always a recipe for wealth creation. There are situations where borrowing could hurt your financial situation more than it helps, such as:
Using the loan on nonessential expenses: Taking out a personal loan to pay for discretionary expenses, such as a vacation or wedding, can be costly and is unlikely to offer a financial ROI.
Borrowing without a clear plan for repayment: Before agreeing to a loan, review the terms, interest rate, and monthly payment to understand your financial obligations and have a solid plan for covering them.
Taking on more debt than you can afford: If your budget is already tight, taking out a loan could create financial strain. Failing to make payments on time can result in late fees and a negative impact on your credit score.
Consolidating debt without changing your spending habits: Using a personal loan for debt consolidation would only be a temporary solution if you continue to accumulate high-interest credit card debt.
Spending the funds on a depreciating asset: If you’re purchasing an item that loses value quickly, like a boat, electronics, or luxury goods, you could end up paying more in interest than the item is worth.
If you’re considering a personal loan to grow wealth, ask yourself how the loan will improve your financial situation over time. Will it help you grow your income or increase the value of your home? If you’re using it for debt consolidation, will you save money on interest or pay the debt off faster? Ensure the loan aligns with your long-term goals and doesn’t add unnecessary risk.
Check that you can comfortably afford the monthly payments without draining your emergency savings. Consider how borrowing will impact your debt-to-income (DTI) ratio too, which compares your monthly debt payments with your gross income. Most lenders prefer a DTI below 35% when considering you for a new loan or line of credit.
Finally, take the time to shop around with multiple lenders before picking a loan. You can often check your rates and prequalify online, a quick process that won’t affect your credit score. By doing your due diligence, you can find your best offer and use the loan to achieve your wealth-building goals.
