How to Make Debt Work for You: Build Wealth with a Personal Loan

Although personal loans are debt products, when used properly they can be a great tool for building wealth.

They can help you free up money in your budget if you use it to consolidate high-interest debt, such as credit card debt. Less credit card debt also helps your credit score, meaning you’ll qualify for lower interest rates if you need to take out a mortgage or car loan in the future.

Personal loans can help you finance a new business venture, take advantage of a good investment opportunity, or even increase the value of your home through home improvements. Knowing how to use personal loans to build wealth can help you achieve your financial goals if you understand the risks.

How to use personal loans to build wealth

To build wealth with a personal loan, you need to use it well.

You may hear financial experts discuss good debt versus bad debt. Good debts are all types of credit that provide a financial return on your borrowed money. Imagine taking out a personal loan to buy a car that will help you get a new job. The payout is the income you earn.

Bad debt is typically money you borrow for experiences, consumables, or depreciation on assets.

Imagine using a personal loan for a vacation instead of budgeting for it. There is no financial return on your money. You may make great memories, but the interest charges and monthly payments won’t help your financial situation.

A personal loan builds wealth by:

• Reducing your overall debts.
• Reducing your revolving debts.
• Increasing the value of your home through home improvements.
• We help you finance investments, a business or a side activity.

A personal loan reduces assets if:

• Paying back eats away at your savings.
• You use it to finance a want, not a want.
• It’s a bandage for bad spending habits.
• You have no plan for what it is for.

1. Debt consolidation

Debt is often the biggest obstacle to building wealth. Credit card debt is harmful because it damages your financial health in two ways.

First, many people get used to making the minimum payment, which keeps you in debt longer. Second, it affects your credit utilization ratio. That can lower your credit score if it’s too high. A low credit score means higher costs when you borrow in the future. It can even affect your ability to rent a house or get a job.

Unlike credit cards, personal loans are paid out in one go, with a fixed repayment schedule and a fixed interest rate. This makes them a better option when it comes to building wealth. These factors can help you avoid the temptations of revolving credit, such as overspending or only paying the minimum amount due. Both habits can worsen your financial situation.

Using a personal loan to consolidate debt can help you build wealth in five ways.

1. Your debt has a repayment date: Personal loans must be paid off within one to seven years, giving you a clear ‘debt-free’ date. If you get rid of your debts faster, you can accrue less interest. Compare a loan with a credit card payoff calculator to see the difference.
2. You’ll probably pay a lower APR: According to Bankrate, the average credit card annual percentage rate (APR) is above 20 percent, compared to an average personal loan rate of 12.21 percent.
3. Your rate is fixed: The rates for a personal loan are fixed for the term of your loan. Credit card rates may change from month to month.
4. Your credit score may increase: Paying off revolving debt can give your credit scores a big boost. A higher score means lower APRs and fees if you need credit in the future.
5. You will receive your money in one go: You cannot reuse the money you receive from a personal loan and there is no minimum payment option. The fixed payment schedule can ensure that you do not borrow more than you need.

2. Investing

There are a number of ways you can use a personal loan to invest. Some involve more risk than others and should only be undertaken under the expert guidance of a financial advisor.

In addition, some lenders may prohibit certain uses, especially purchasing stocks or financing college tuition. Be sure to check with your lender before using these options.

• Buy shares: Using debt to trade the stock market is very risky. Unless you have trading experience or can afford to lose the money you borrow, this is probably not a good idea.
• Fund repairs to a rental fixer upper: If you have a knack for DIY work, you can buy run-down properties and use a personal loan to fix them up and rent them out. If rental income exceeds your mortgage payment, you will end up with an asset that your tenant will pay off.
• Repairing and flipping houses: If you don’t want to be a landlord, you can improve and convert properties for profit. Most personal loans, unlike a mortgage, do not require collateral to qualify. So you can get the money you need without having to worry about the condition of the house you are repairing.
• Get additional education, training or certifications: Investing in yourself can make sense if it increases your earning potential. The return on your investment will come in the form of higher earnings and more promotions because of the additional skills you gain.

3. Financing home improvements

Personal loans can also be used to build wealth by making renovations or improvements to a property that increase its value. Using a personal loan for home improvements gives you quick access to cash without tying up the equity in your home.

Some lenders offer repayment terms of up to 144 months for home improvement loans. That is as long as some home loan terms.

They can also be a good alternative to secured loans, such as a home equity loan or a home equity line of credit (HELOC), because you don’t risk losing your home if you default on payments. The approval process is also less complicated because it does not require an assessment of your home’s value.

It’s important to choose renovations that have the best chance of increasing the value of your home. When you resell, you’ll recoup most or all of the costs for these top renovations:

1. Installing a new garage door.
2. Replacing your entrance door.
3. Add stone veneer.
4. Renovating your kitchen.
5. Installing new siding.
6. Add a deck.
7. Renovating your kitchen.
8. Convert your HVAC system.

Assessing your debt tolerance

Before trying any of the above strategies, it’s important to understand whether they fit within your budget. That means assessing your debt tolerance.

Debt tolerance is a term that refers to how much you can borrow compared to what you earn. Lenders set their own forbearance limits based on debt-to-income ratio (DTI) guidelines. However, it’s also important to look at your residual income: how much extra money you have left over after you pay all your regular expenses.

Debt-income ratio

Your DTI ratio is measured by dividing your monthly debt payments by your pre-tax income.

For example, if you earn $10,000 per month and owe $3,000 per month, your DTI ratio is 30 percent (3,000 divided by 10,000 = 30%). Financial advisors often recommend keeping your DTI ratio at 36 percent or less, including any new debt you take on.

However, lenders can set their own DTI ratios, and some let you borrow up to 50 percent of your income.

However, they often charge a higher rate for a high DTI ratio because of the added risk of defaulting if your income suddenly drops due to reduced hours or a layoff.

Residual income

Consider how much cash you have after paying your typical fixed and variable expenses each month. Your lifestyle may include eating out at restaurants, a long commute to work that eats up gas or braces, or taking a child to dance lessons.

After adding a loan payment, will you have enough left over to handle emergencies?

Don’t forget to think about your savings goals for retirement and education. Just because a lender approves you for a high DTI ratio doesn’t mean your money habits can afford it.

What is considered rich?

Before taking out and investing in a personal loan, it’s important to think about your financial goals. How do you define success and how much money do you need to make to achieve it?

According to Bankrate’s latest Financial Freedom Survey, the average American thinks they need about $233,000 a year to feel secure or comfortable with their finances. That’s more than triple the country’s average salary, which is just over $75,000.

However, that figure is too low to feel rich. In fact, Americans said they needed an average of as much as $483,000 a year to feel wealthy or achieve financial freedom.

Other insightful conclusions from the study include:

• Only 28 percent of Americans consider themselves financially secure.
• 63 percent of Americans say they feel high inflation is keeping them from being financially secure or comfortable.
• Women’s average estimate of the amount of money they need to feel rich is $8,000 higher than men’s average estimate.

The bottom line

Personal loans, when used wisely, can be a valuable wealth-building tool. You can consolidate high-interest debt, invest in profitable ventures, or finance home improvements.

However, it is important to determine your debt tolerance and make responsible lending decisions. With the right approach, personal loans can be a powerful tool for improving your financial situation and building long-term wealth.

So don’t be afraid to explore the possibilities of personal loans. Make sure you make informed decisions that will lead you to financial freedom.