Personal Loans Are Extremely Flexible. Here's Why That's Both Good and Bad

You have different choices when it comes to borrowing money. You could rack up a balance on a credit card you already have, but that might mean spending a lot of money on interest.

Or, you can look at taking out a personal loan. These loans let you borrow for any purpose, and if you have great credit, your chances of getting approved for one are pretty high.

As of the end of 2022, U.S. personal loan balances reached $222 billion, according to TransUnion. So clearly, they're a pretty popular borrowing choice. And the reason for that most likely boils down to the fact that they're extremely flexible. But while that flexibility is a good thing to some degree, it can also be somewhat of a curse.

The problem with too much leeway

When you take out a mortgage, you must use your loan proceeds to finance the purchase of a home. Similarly, if you sign an auto loan, you're doing so to buy a car.

Personal loans work differently. When you take out a personal loan, that money is yours to use for whatever purpose you deem necessary. You could take out a personal loan to renovate your home, fix your car, or upgrade your electronics so you're more efficient at your freelance job. But you could also take out a personal loan to go on vacation, spend money on clothing, and follow your favorite band on tour for the summer.

And there lies the problem with personal loans. Because they're so flexible, you may be tempted to borrow money for something you should really be saving up to purchase instead.

It's one thing to take out a personal loan to replace aging appliances in your home that are not only not so functional, but are costing you money in the form of higher electricity bills. It's another thing to take out a personal loan so you can buy the latest gaming system and upgrade to a better TV when you have a perfectly good one in your living room.

Remember, when you take out a personal loan, you're signing up to pay interest on the sum you borrow. And these days, interest rates are up across the board on the heels of the Federal Reserve's string of rate hikes. So all told, a $1,400 TV might end up costing you $1,700 when you factor in the interest you're paying on it.

Also, there are consequences to falling behind on personal loan payments, just as there are consequences to failing to repay a mortgage or auto loan. Failing to repay a loan could damage your credit score, making it pretty much impossible to borrow money should you need to do so in an emergency. And that's why the flexibility to use a personal loan for any reason isn't always such a great thing.

Borrow for the right reason

If you're going to take out a personal loan, do so to make an investment or improvement in your home or vehicle. You might even take out a personal loan if you're using the money to kick off a business venture.

But don't take out a personal loan and spend the money on frivolous things like gadgets or tickets to live events. These things might be important to you, but if so, you should make a point to save up for them ahead of time.

Taking on any amount of debt means having to factor ongoing payments into your budget. So if you're going to go this route, it should be for a purpose that's truly essential.