Five Personal Loan Rules Financial Experts Say They Rarely Break

A manageable-looking monthly payment does not necessarily make a personal loan a sound choice. Financial experts say borrowers should first identify what the loan will accomplish, then weigh its full cost against their budget and alternatives.

That matters whether the money is for debt consolidation or a one-time expense: borrowing can help address a specific need, but it may deepen an ongoing budget shortfall. Experts also caution against treating a lender’s approval amount as a recommendation to borrow that much.

What should you calculate before borrowing?

Ethan Aiem, founder and CEO of Klendify, advises borrowers to name the specific problem a loan would solve and consider whether taking on debt would bring a measurable financial benefit. If the reason is simply needing money “this month,” he says to proceed with caution.

Heath Squier, CTO of Equity Edge Lending, recommends comparing total repayment and the effect on the monthly budget—not just the payment amount. A lower payment can come with a longer term, an origination fee or a higher overall cost.

Before comparing lenders, Squier suggests listing the amount received after fees, annual percentage rate (APR), monthly payment, total interest, payoff date and any prepayment penalty. Aiem gives a straightforward test: if borrowing $10,000 means repaying $13,000, the borrower should have a good reason the money is worth the extra $3,000.

Can a loan fit your budget or financial goal?

Aiem says to base affordability on actual cash flow after housing, essentials, existing debts, taxes and a modest savings amount. Borrowers can also test whether they could keep making payments with lower earnings or an unexpected $1,000 expense. Squier says loan approval shows what a person can borrow, not what they should borrow.

Debt consolidation may make sense when a personal loan replaces more expensive debt and the interest and fee savings are worthwhile. But Aiem warns that borrowers can turn one problem into two if they run up balances again on credit cards they have paid off.

Ryan Thomson, an assumable mortgage specialist at The Assumable Guy, advises against using a personal loan for a home down payment. He says a $20,000 loan at 12% adds roughly $444 a month in obligations and can raise a buyer’s debt-to-income ratio, potentially jeopardizing mortgage approval while leaving them with two significant payments.

This report draws on information from AOL.com.