When times are tough, we sometimes need a quick fix. And when those tough times include being short on cash, it can be hard to navigate. It’s easy to see why a personal loan may be the answer we are looking for. But is it a good idea?
Here’s what you should think about when determining if you should take out a personal loan in a crisis.
What alternatives are there to a personal loan?
Before you decide that a personal loan is the only option, consider what alternatives you may have to come up with the money you need. Do you need a lump sum of money, or are you having a hard time consistently making monthly payments?
If money is tight every month, the following might be good alternatives for you.
- Consolidate to a 0% credit card. If you have good credit, you may qualify for a 0% balance transfer. This will allow you to transfer high interest debt to this new card and save a lot in interest. You typically have 12-18 months before interest kicks in, so this might give you the breathing room to get your finances back on track (but be sure you repay everything in that time period).
- Refinance your car loan. If you need some extra money every month, you can try refinancing your car loan. Refinancing to a lower car loan APR can save you a lot of money in interest every month. But even if you don’t qualify for a lower car loan APR you can still get some breathing room. When you refinance you can change your repayment plan. Lengthening your repayment will reduce your monthly payments drastically, as you will have more time to pay off the balance.
- Try to negotiate your bills. If other bills such as student loan payments or mortgage payments are putting a lot of pressure on you, you can call and try to negotiate. They may be able to defer payments for a few months to give you some room. You may be able to set up large bills (such as medical bills) as payment plans.
If you need a lump sum of money, the following might be good alternatives for you.
- Ask friends and family. We get it–it’s awkward to ask loved ones for a favor. But if you are desperate, it might be your best option. If you feel uncomfortable, offer to pay them a small amount of interest so that it doesn't feel awkward.
- Request a payday advance. Some companies may be able to pay you in advance if you have a good work record.
- Take a loan from your retirement account. Depending on your account you may be able to take out a loan. For example, if you have an IRA you can take out one loan per year as long as you repay in 60 days.
- Borrow against your life insurance. If your life insurance has a cash value (sometimes called permanent life insurance) you can borrow against it and you will have the rest of your life to repay. If you do not repay it, the money is simply detracted from your insurance payout when you die.
- Look into local resources. Local nonprofits and charities might be able to assist you depending on your situation.
Is a personal loan a good idea?
Whether or not it is a good idea to get a personal loan will depend a lot on your individual situation. In general, it is not a good idea to use a personal loan for your basic living expenses unless you are desperate and have exhausted all other options available to you. This is because personal loans tend to have high interest rates, and if you are having trouble month to month, you will more than likely have trouble repaying your loan in the near future.
Under no circumstances should you take out a payday loan. These predatory loans have annual interest rates of well over 300% and can quickly cause a serious problem for you.
But if you have nowhere else to turn, a personal loan may be your only option. Especially if you need a large sum quickly. Here are some questions you should ask yourself when determining if it’s a good idea to take out a personal loan.
- How much will this loan cost me? Think about the interest rate and how much you will be required to pay every month when repayment begins.
- How quickly do you need the money? Sometimes fast cash is more expensive to borrow, but if you need it immediately you may not have an option.
- How quickly do you want to repay? The sooner you repay, the less interest you will be responsible for.
If you decide that a personal loan is your only option, it’s important to shop around and compare. If you have a good credit score, you will likely have many options open to you. Personal loans are unsecured, meaning there is no collateral to repossess if payment is not made. Because of this, unsecured loans tend to have a higher interest rate than secured loans. Be sure to consider all of the different lending options you have available to you.
- Credit Unions. Credit unions will consider your credit history, credit score, membership status, and income when determining if you are eligible for a loan. They do not only focus on your credit score, which may give you a better chance if your score isn’t stellar.
- Traditional Banks. Traditional banks tend to have high credit score and income requirements, but they often have the best rates around.
- Online Lenders. A good credit score can help you easily secure a personal loan from an online lender.
Apply to a few different lenders so you can compare offers. Be sure that you can handle the repayment schedule before you sign. Defaulting on a personal loan can significantly and severely damage your credit score. And damage to your credit score can affect you for a long time.
How much money should be in a personal emergency fund?
The best way to avoid a personal loan in times of crisis is to have an emergency fund for yourself. No matter what your situation is in life, you should have some sort of emergency fund set up for yourself.
You should have three months’ worth of expenses saved up if:
- You’re young and healthy
- You have a stable job
- You do not have dependents
- If you have a partner, your partner is financially stable
You should have six months’ worth of expenses saved up if:
- You have a lot of expenses and/or a lot of debt
- Your job is not stable
- You have dependents
- You are the sole provider
You should have one year worth of expenses saved up if:
- You are older or have health issues
- You are close to retiring
- You are the sole provider for many dependents
If you do not fit into one specific bracket, it’s always better to over-save than to under-save. To determine what one month of expenses looks like for you and family, take the following into consideration:
- Your mortgage/ rent
- Your utilities (electricity, gas, water, etc)
- Your car payments
- Your insurance payments
- Your loan payments (student loans, personal loans, etc)
- Your groceries
- Your medical bills and prescriptions
- Any other monthly expenses (subscriptions, vet bills, etc)
Once you know what your savings goal is, try to fit this into your monthly budget. Treating your emergency fund as if it is a bill that you must pay every month will help ensure that you continue to add to your fund consistently. Here are some of our top tips for growing your emergency fund:
- Add a savings account to your direct deposit. Opening a savings account that is linked up to your direct deposit. You can have a percentage of your paycheck deposited into it so that the savings build automatically.
- Use a bonus, tax refund, or cash back reward to start your fund. While it’s not an exciting way to use these types of income, it is an easy way to get an emergency fund started with little hit to your monthly budget.
- Work to trim your monthly budget, and allocate savings to your emergency fund. By cutting unnecessary costs (such as switching to generic groceries, cutting subscription services, and refinancing your car loan) you can create a lot of wiggle room in your budget. Allocating that money to your emergency fund can help you build it up quickly.
A personal loan may help you out of a crisis if it’s necessary, but working to build an emergency fund ahead of time can ease your financial burden much more effectively.
You can’t plan for emergencies, so sometimes you need to get creative when problems arise. A personal loan can help you out of a jam, but it should only be used when there are no other good alternatives.
Working to build an emergency fund can help you prepare for the unexpected. Looking for ways to save money in your budget can help you build that financial safety net. Refinancing your car loan is a great way you can free up money and get your finances on track. To find out just how much money you can save, contact Auto Approve today!