6 Ways to Use a Personal Loan Responsibly

Cheerful man responsibly spending personal loan

A personal loan is a versatile borrowing option when you need to finance a purchase or consolidate debts. With lower average interest rates than credit cards, predictable payments and flexible repayment terms, a personal loan can be the best option for financing a number of goals.

But a personal loan can also quickly turn into an expensive way to borrow. And, if mismanaged, a personal loan can do substantial damage to both your credit and your full financial situation. Before you decide to borrow, know how to best manage a personal loan. Here are six tips for using a personal loan responsibly.

1. Shop Around for the Best Rate

It can be exciting to see that you're preapproved for a personal loan, especially when you're really looking forward to a purchase or opportunity for consolidation. But just because one lender preapproves you, that doesn't mean they're the one you should go with.

Before you formally apply, compare rates on personal loans to find the most affordable option. The simplest way to compare personal loan offers is to use a loan matchmaker. Experian Credit Match™ shows you personal loans from lender partners that you're likely to qualify for based on your credit profile. You can compare loan terms in one simple hub to find the best option for you.

2. Check for Fees

As with any form of credit or borrowing, it's crucial that you read the fine print. Personal loans sometimes come with undesirable fees. Notably, some personal loans charge high origination fees, which are charged as a percentage of the full principal amount you borrow.

For example, if you take out a $10,000 personal loan and the lender charges a 5% origination fee, then you'll lose $500 right off to this fee. That money will typically come out of the loan funds before they're dispersed into your bank account. To get the full amount you ask for, you may need to borrow—and eventually pay back—more due to origination fees.

Another fee you should always check for when you borrow is a prepayment penalty or early payoff fee. This is a fee some lenders charge when you make early payments or pay your loan off before the end of the term. Because it's in your favor to pay off interest-bearing debt sooner rather than later, it's probably best to avoid prepayment penalties by steering clear of personal loans that include them.

3. Calculate the Total Cost of Your Debt

While it's true that paying at least the minimum on your personal loan will keep the debt in good standing, it's also a costly way to manage high-interest debts long term. If you have the extra funds, consider the benefits of paying more than the minimum on your personal loan. That way, you'll pay off your loan faster and save more in interest over time.

To see why you should pay more than the minimum, calculate the total cost of your debt. Use a personal loan calculator to see how much money you'll spend on interest over the life of the loan.

Personal Loan Calculator

The information provided is for educational purposes only and should not be construed as financial advice. Experian cannot guarantee the accuracy of the results provided. Your lender may charge other fees which have not been factored in this calculation. These results, based on the information provided by you, represent an estimate and you should consult your own financial advisor regarding your particular needs.

4. Budget Before You Borrow

To manage a personal loan responsibly, it's wise to do a deep dive into your finances before you borrow. But even if you already have a personal loan, assessing your budget can help you manage your loan effectively and make any necessary changes.

To budget for debt repayment, subtract your baseline expenses from your income. Include your housing payment, bills, debts and basic expenses, necessary clothing and the like.

Then, evaluate how much you can afford to tack onto your monthly bills when you take on a personal loan payment. You could use a budget method such as the 50/30/20 plan to determine if an additional debt would put a burden on your money management.

5. Make On-Time Payments

Perhaps the single most important factor in responsibly managing your personal loan is always making on-time payments. Missing or making a late payment can result in being hit with late fees from your lender.

And if you are 30 days or more past due on your payment, your lender will likely report the missed payment to the credit bureaus. This takes a toll on your payment history and, consequently, can have a big, negative impact on your score.

6. Know What to Use Personal Loans For

One of the best ways to use a personal loan responsibly is to be selective about how you use it. While you can use a personal loan for nearly anything, some uses may be better than others.

Some of the most common uses for a personal loan include debt consolidation, medical bill payment, home improvement and repairs, moving costs and any large, unexpected expense. But a personal loan may not always be the best option for these expenses. For example, you might get better rates—and possibly tax breaks—if you use a home equity loan to cover home renovation costs. As another example, paying off medical debt with a personal loan may not be the best choice if you can work out a payment plan with your medical provider. A payment plan could save you money and allow you to avoid putting your credit on the line.

More broadly, whenever you're considering borrowing, weigh what a debt will give you against what a debt will cost you. In other words, weigh the interest rate you'll pay to borrow against the benefits you'll gain from financing.

Using this line of thinking, a debt consolidation loan with a lower interest rate and fees than your credit card balances could be a good use of a personal loan. Using a personal loan to finance a vacation, on the other hand, may not fit this rule.

The Bottom Line

The ability to borrow flexible funds for a variety of purposes and then repay the loan over time can unlock a lot of opportunities. But if you aren't able to responsibly manage your personal loan, the impact on your finances and credit can restrict future financial opportunities.

In addition to being intentional and cautious before you borrow and responsibly managing your debts, be prudent about tracking your credit. You can monitor your credit for free through Experian and get alerts for new inquiries and debts, which can help you detect signs of identity theft and fraud as early as possible. You'll also see how your credit behaviors, such as the size of a credit card balance or how often you apply for new credit, impact your score.