In many cases, borrowing money is seen as something to be avoided. After all, if you take out a loan, you have to pay interest, which is an additional cost. You also commit your future income to making payments, which gives you less flexibility going forward.
But despite the common misconception that borrowing is always bad news, the reality is that there are situations where getting a loan is a good thing. Here are three.
1. When your loan improves your equity
Sometimes you can borrow for something that will actually make you richer in the long run.
One of the best examples is a mortgage. A mortgage carries a very affordable interest rate, and the interest can even be deducted from taxes if you itemize it when filing returns. Plus, it allows you to buy a home, so you can start building equity, stop wasting money on rent, and hopefully benefit from rising property values.
Another good example is a business loan. If you can borrow money at a low rate in order to start a profitable business that increases your income, it might be a smart move.
You will want to consider the cost of borrowing against the future value of the asset you acquire with the loan to decide if debt is good or bad for you.
2. When Your Loan Makes Paying Off Debt Cheaper and Easier
Say, for example, you owe a lot of money on credit cards that currently charge 20% interest. If you could qualify for a personal loan to pay off your credit cards with an interest rate of 9%, taking out this new personal loan could cut your rate in half. And the effect could be even more dramatic if you take out a personal loan to repay your payday loans, which can sometimes have interest rates above 400%.
If you can get a new loan at a lower rate than your current debt, refinancing could be a very smart financial decision. And if you’re using your new loan to pay off multiple debts, this level of debt consolidation might actually make repaying both cheaper and easier since you’ll only have one monthly payment at a low interest rate.
3. When your loan helps you build credit
Lenders like to see a mix of different types of credit on your credit report. This means that you will have a better score if you have loans with fixed repayment schedules with credit cards. For this reason, you might want to take out a small car loan when buying a car and pay it off quickly, even if you could afford to pay cash for the vehicle. Or you might want to take out a small, low-rate personal loan to finance a purchase and then focus on paying it back as quickly as possible.
There are even some specific types of personal loans that are uniquely designed to help you build credit, like credit builder loans, which cater to bad credit borrowers who might otherwise not be able to get approved for financing. These loans could help you significantly improve your credit rating, which could make future borrowing easier.
As you can see, there are several reasons why borrowing can be a good thing. The big question is not “Are personal loans bad? âorâ Are other types of credit bad? âInstead, ask yourself what you are doing with your debt. If you are using it as a tool to improve your situation, then it is good. But if you are borrowing money to finance a lifestyle you can’t afford, you might want to think twice.
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