What a person does with their money is their business, right? Not always. Lenders are indeed interested in how borrowers plan to use the funds they’re loaned—in fact, the reason for a loan is one of the application questions.
But does loan purpose really matter? Keep reading to find out.
Related: How to use a personal loan for loan consolidation
Common Reasons for Getting a Loan
Most people have something particular in mind when they decide to borrow money. According to a pre-pandemic 2019 survey from Experia, about three out of every four people who are considering taking out a personal loan say the decision is motivated by a specific upcoming need or life event.
But although every person sees themselves and their individual needs as unique, it turns out the reasons for taking out a personal loan tend to fall into some fairly common buckets:
1. Large purchases
Whether a new car, a computer or other big-ticket items, being able to cover a large purchase is the most commonly cited reason for a loan. Among those who had already taken out a personal loan, 28% said they did so to pay for a large purchase.
2. Debt consolidation:
Total household debt in the US surged to $14.56 trillion during the pandemic, according to data from the Federal Reserve Bank of New York, including credit card balances, student loans, mortgages, and other lending products. For 26% of Americans, the reason for a loan is to consolidate multiple debts, Experian found.
3. Home improvements
Whether it’s a full renovation, a nice-to-have upgrade such as new floors or paint, or something more critical such as new plumbing or a roof, 17% of Americans put their personal loan funds towards home improvements.
4. Loan refinancing
Similar to debt consolidation, loan refinancing can help make it easier for an individual to pay back what they owe—in this case via a more favorable interest rate or loan repayment terms than those attached to the original loan. Nearly one in 10 personal loans are used to refinance other existing loans, Experian found.
5. Something else
Nearly one-third of respondents to the Experian survey said they plan to take out a loan for another purpose that wasn’t listed.
As one might expect, the pandemic has shifted some elements of how people handle personal finances. According to a survey from Ipsos for Forbes Advisor, the most common reasons for taking out a personal loan during the pandemic were:
- Home improvement projects (25%)
- Medical bills (21%)
- Debt consolidation (20%)
- Financing a vehicle (20%)
- Auto repairs (20%)
Why Loan Purpose Matters
Banks consider a number of factors in addition to the reason for the loan, such as the amount asked for and the applicant’s credit and employment history, among others. The purpose of including such information on a loan application is so that a bank can assess the potential risk of lending money to an individual.
But the borrower’s reason for needing a loan can be a factor, too, because how much money is needed and how the debt can be repaid—both of which might be influenced by the underlying need—might make some types of loans a better fit than others.
The loan purpose might also inform the ultimate decision whether to borrow money at all, after calculating the costs. Some reasons for taking out a loan—such as to pay for improvements that increase the value of a home or education that can boost earning power—can provide benefits that, over time, may even outweigh the cost of borrowing.
Basically, the more time spent considering the specific reasons for applying for a loan, the better equipped someone will be to find the best loan for their needs and financial situation.
Planned vs. Unexpected Expenses
Whether it’s a wedding, education or a home renovation, there are some expenses that can be seen and planned accordingly. Others, such as an emergency medical bill or unexpected car repairs, require a sudden inflow of cash—sometimes quickly.
What to consider:
Having a longer lead time before borrowing money can give an individual more time to compare loan offerings and typical requirements for getting approved, helping them to find more favorable rates and terms. For example, secured loans may have lower interest rates than unsecured loans because the loan is secured with collateral, potentially lowering the risk to the lender.
But the process of obtaining such a secured loan can also be slower due to the time it takes to make sure the collateral being used is of sufficient value. As such, an unsecured personal loan may be the quickest way to obtain funds to cover unexpected expenses, although it may cost more overall.
Smaller vs. Larger Expenses
In 2020, the average personal loan balance in the U.S. was $16,458, according to Experian. But that number only tells part of the story. About 40% of Americans don’t have sufficient cash on hand to cover an unexpected $400 expense, a study by the Federal Reserve found, a finding that highlights that depending on the reason for a loan, a person may need to only borrow a little or a lot.
What to consider:
Calculating the amount needed before applying for a loan and seeking out a loan that’s the right fit is a good idea. An alternative way to access the funds—such as charging it to a credit card or dipping into savings—may be a more favorable option than a personal loan after factoring in potential costs such as origination fees charged by some lenders.
One-time vs. Ongoing Expenses
Will the loan funds be used to cover a defined, one-time fee, or will the expenses be ongoing? Depending on the loan purpose, a personal loan might not be the right fit.
What to consider:
Funds from a personal loan are disbursed in one lump sum, and interest is paid on that sum according to a fixed repayment schedule.
If the loan purpose is an expense that is ongoing or variable, such as wedding or home improvement costs, a line of credit might make sense financially, since interest is only charged on the balance drawn, and money borrowed can be repaid on a more flexible basis. Lines of credit tend to come with variable instead of fixed interest rates, however, so the overall amount due may be hard to predict.
Loans To Pay Off Other Loans
Using one debt to pay off another can sometimes be a sound financial strategy. But when debt consolidation or refinancing is the loan purpose, not just any personal loan will do.
What to consider:
Debt consolidation and loan refinancing requires some number crunching to ensure the new loan is more favorable than the debt it’s replacing, factoring in any fees or penalties attached to the original loan(s).
The Takeaway
There are, indeed, different types of loans for different purposes. Applicants may have their own reasons for wanting a loan, but lenders will want to know what the funds will be used for. There may be certain loans better suited to certain funding needs than others, and a lender will likely want to make sure the loan suits the purpose.
Learn more:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
SoFi Loan Products
SoFi loans are originated by SoFi Lending Corp. or an affiliate (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612, NMLS # 1121636; For additional product-specific legal and licensing information, see SoFi.com/legal.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
More from MediaFeed:
6 strategies to pay off student loans quickly
Life can get expensive. When you factor in things like rent or mortgage, groceries, child care expenses, transportation costs, and more, it adds up quickly. For 45 million Americans, their monthly budget also includes student loan payments.
If you’re trying to figure out how to pay off student debt faster, read on for help.
If you’re able to lower or eliminate student loan debt, you’ll have more money to save for a down payment or for retirement. Consider this: College graduates turning 30 who have student loans have significantly lower retirement assets than those without student loans, according to a study by the Center for Retirement Research at Boston College.
So what’s the fastest way to pay off student loans? There’s no one right answer, but these tips could help you hasten repayment so you can focus on other financial goals.
Related: Do
student loans count as income?
kate_sept2004/istockphoto
One of the most effective ways to possibly get ahead of student loan debt is to pay more than the monthly minimum. There are no prepayment penalties for federal or private student loans, so it might be one of the fastest ways to shrink your debt.
As a bonus, when you put extra money toward the principal loan balance, you’re also shaving off the total cost of interest you may otherwise pay over the life of the loan.
You might be surprised how much an additional monthly $50 payment can trim off your debt. If your monthly budgets are too tight to make an additional monthly contribution, you might consider increasing your payments every other month or quarterly.
To make the most of prepayments, the additional payments should be applied to the loan’s principal. Some loan servicers may apply a payment to the next month’s payment instead of deducting it from the loan balance. You may want to contact your loan servicer to make sure prepayments are applied to the principal.
DO NOT USE
If making monthly prepayments to your student loans is out of the question, consider making a lump sum payment. That means making use of “found money.” Instead of treating a tax refund, financial gifts, bonuses, or a raise at work like “fun money,” you could use it to double down on your debt, or apply just half of the windfall.
It may also be a good time to review your spending habits and see where you might be able to find some extra cash. Even minor adjustments like taking public transportation instead of a cab or finding street parking instead of paying at a garage could add up.
When you find areas in your spending to cut back, consider adding that money to an account dedicated to your student loan repayments.
DepositPhotos.com
If you’re still searching for how to pay off student debt faster, you could try finding an additional source of income and putting that money toward debt.
What are your skills, hobbies, and interests? While it may take perseverance to find the right side hustle
https://www.sofi.com/blog/launching-side-hustle/
, it could wind up being one of the fastest ways to pay off student loans.
There are tons of apps that offer flexible, part-time side hustles. If you’re crafty, you could try selling your creations at an online marketplace. If you’re a photographer, writer, or editor, you could try finding a freelance gig. Once you get your side hustle going, the additional income could be regularly put toward extra student loan payments.
depositphotos.com
You could speed up loan repayment if you can find a way to have someone else contribute.
Deposit Photos
Before the coronavirus pandemic, an estimated 8% of employers offered student loan repayment assistance as a benefit. The CARES Act of 2020 gave companies an incentive to offer the benefit, which was then extended through 2025.
Employers can contribute up to $5,250 per employee each year toward qualified education expenses like student loan assistance without raising the worker’s gross taxable income.
mphillips007/istockphoto
Some volunteer opportunities might ease your student loan balance. For example, members of the Shared Harvest Fund can get a stipend applied to their student loans if they match up with a nonprofit organization that needs their talents.
You can choose the cause you like or filter by project. So, for instance, if you’re a lawyer, you can consult with a nonprofit organization looking to change its structure. A social media whiz can help set strategy for a therapy-pet agency.
yacobchuk / istockphoto
Your family members and friends want you to succeed, so why not ask them to contribute to your student loan instead of buying something you don’t really need on your birthday? One site, giftofcollege.com, lets you set up a profile, link to a student loan, and ask for contributions via social media.
DepositPhotos.com
When it comes to finding the fastest way to pay off student loans, you could try using the debt snowball method. Here’s how that works.
First, take a look at your loans, disregarding the interest rates, focusing on the balances instead. While you should be making at least the minimum monthly payment on all your loans, the debt snowball method has you put any additional money toward the loan with the smallest balance first.
Once that loan is paid off, you’d use the money you were paying on the old loan payment amount and roll it to the next smallest debt. The idea is to continue using this method until all of your loans are paid off. Each time you pay off a loan, it feels like a win that helps you see the progress you’re making.
istockphoto/demaerre
Refinancing your student loans with a private lender means taking out a new loan that pays off your existing loans and has a new interest rate, term, and monthly payment.
Depending on your credit score and income (among other factors), you may be able to secure a lower interest rate when you refinance your loans, which means the loan may accrue less interest over time (depending on the loan’s term). Lenders generally offer both fixed-rate and variable-rate loans, and often give you the option to extend or shorten your repayment term.
fizkes/istockphoto
If you have exclusively federal student loans, you could consolidate them into a Direct Consolidation Loan, with one monthly payment. The new, fixed interest rate will be the weighted average of your existing interest rates rounded up to the nearest eighth of a percentage point.
Consolidation can lower your monthly payment by giving you up to 30 years to repay your loans, but a longer term means more payments and more interest.
Before refinancing federal student loans, it’s best to weigh the borrower protections of those loans against refinancing with a private lender, who can’t offer the same federal benefits. For example, if you are enrolled in an income-driven repayment plan or are applying for Public Service Loan Forgiveness, refinancing might not be your best option.
But if you are enrolled in a standard repayment plan, refinancing could be an option.
Kerkez / istockphoto
How to pay off student loans quickly? There are a few strategies to explore. One or more of these six suggestions could be the ticket to chipping away at the debt faster.
Learn more:
This article
originally appeared on SoFi.comand was
syndicated by MediaFeed.org
.
IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS PLEASE BE AWARE OF RECENT LEGISLATIVE CHANGES THAT HAVE SUSPENDED ALL FEDERAL STUDENT LOAN PAYMENTS AND WAIVED INTEREST CHARGES ON FEDERALLY HELD LOANS UNTIL THE END OF SEPTEMBER DUE TO COVID-19. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE IN DOING SO YOU WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. CLICK HERE FOR MORE INFORMATION.
SoFi’s Relay tool offers users the ability to connect both in-house accounts and external accounts using Plaid, Inc’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score provided to you is a Vantage Score® based on TransUnion™ (the “Processing Agent”) data.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
Moussa81/ istockphoto
Featured Image Credit: Kerkez / istockphoto.
