3 situations a personal loan could save you from further debt

Unless you need money to urgently purchase a bazooka, before your home gets overrun by a gang of marauding zombies, do not take up a personal loan. Yes, you heard us right, don’t do it.

Taking out a personal loan is almost never a good idea. No matter how it sounds in your head, nothing is worth putting your finances at risk by spending beyond your means.

So don’t get a personal loan to finance your wedding, or a vacation, and especially not a car. There are car loans that offer much better terms and interest rates than a personal loan.

That being said, there are 3 situations where applying for a personal loan is not only a good idea, but might actually save you from further debt.

1. Consolidating credit card debt

We cannot recommend this enough. It makes no sense for you to keep rolling over your outstanding credit card bills and incurring 26.8per cent interest a year on them.

If you apply for a personal loan for the same amount as your outstanding credit card bill, you’ll end up saving more money because a personal loan tends to have an effective interest rate of about 18-20per cent. Yes, it’s still high, but it’s lower than your credit card and that’s what’s important.

But in case you think it’s an excuse to start charging your credit card again, you must remember that a personal loan is not a magic wand that will miraculously clear off your debt. In fact, you should probably cut up your credit cards to stop yourself from spending more! The personal loan simply allows you to become debt free on your own terms, not a collection agency’s.

To look for a personal loan with the lowest interest rates, use our comparison tool. Just be sure to look out for the terms and conditions. Some banks offer lower interest rates, but make money back through higher “processing fees” and “annual fees”.

2. Paying off large transactions made on your credit card

Say you normally pay off your credit card bills in full and on time. Great! But it’s the new year and one of your resolutions is to sign up for a fitness program or gym membership. Except the particular gym you’re at doesn’t offer you a 0per cent interest free instalment plan on your credit card. Worse, the cost of the package is a thousand dollars over your monthly budget. What do you do?

A cost-effective solution would be to pay for it with your credit card, then take out a personal loan at a lower interest rate to pay off the credit card bill, and service the loan instead.

Say you apply for a personal loan for a term of a year or so. Yes, there will still be interest you need to pay, but it’ll be much cheaper than rolling over the debt on your credit card.

For example:

A $1,000 loan for a year at an interest rate of 18per cent per year, will cost you $180. But if that $1,000 remains on your credit card bill, the interest incurred would be at least $268. As long as the personal loan you take up does not charge interest that is greater than the credit card interest rate, it makes sense to do this. What’s more, you still get to enjoy the credit card rewards or cashback on the transaction.

Why should you do this with large-ticket items? This is due to the fact that some credit card companies do not tell you that interest charged is based on the TRANSACTION AMOUNT, not on what’s remaining as you pay it down. That means, even if you’ve paid off 99per cent of a $5,000 transaction and have only $50 left to pay, the interest charged is STILL based on $5,000 and not $50! Booooooooo!

3. Paying for emergencies

We’ve talked about setting aside an emergency fund before, but shit does happen and it never seems to wait until you’re able to afford it.

When those emergencies have to do with important things like household or car maintenance or an unforeseen medical situation, you can’t afford to wait until you have enough money saved up till you deal with the problem. You need to deal with the problem as soon as possible, because you risk losing much more than just a few hundred dollars in interest. Your best bet is to apply for a personal loan.

When it comes to medical emergencies, money can be earned, but a life or a limb does not regenerate. Even if you’re a zombie.

This article was first published in MoneySmart.