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A consumer loan provides you with both flexibility and the opportunity to spend the money as you see fit. Unlike credit cards, these loans are usually supplied with a lower interest rate and 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 doesn’t need to put up collateral for the loan. Yet, the lender(s) have other ways of getting their money back, so it should not be misinterpreted.
Such loans are a better fit for individuals with stable finances. In other words; people with a steady income and a low to moderate degree of household debt.
With a decent credit score you’d also get 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 those cases where there are no realistic ways to secure the loan. For example, you’d never finance your house this way (that’s why we have mortgages), but you may want to use it for other purchases that can’t be secured.
Loans with no collateral should also be used to finance goods with a long lasting value. For example, to build a shed where you can work on your hobbies or a lawn mower that will last for many years.
What should it not be used for?
Here’s a short list, with some items one should not be financed with unsecured loans:
1. Fixed monthly costs: Unless we’re talking about a one-time exception (say the laundry machine broke), you should never use it to cover your fixed monthly costs.
If you can’t afford paying these expenses on a monthly basis, it’s an indicator that your household budget is under severe strain. Borrowing money to pay the bills will only add to the financial strain of your household.
2. The down payment on a mortgage: You should never finance the down payment requirements with anything but your own savings. There are several reasons for this, but the most important one has to do with the financial risks you’re taking.
Should interest rates rise (or if you lose your income), you’d have severe problems covering the monthly mortgage bills. An unsecured loan would only add stress to the situation.
Also, let’s not forget why the banks are required to demand a down payment in the first place. It’s so that you’d take less of a financial chance when you sign for the mortgage.
3. Interest on other loans: This may seem obvious, but should not be ignored. Never use a consumer loan to pay interest on other loans. You’re just pushing the problem ahead of you, adding fuel to the fire.