How to Use a Personal Loan to Make Money

Debt consolidation for wealth building

Consolidating debt with a personal loan can help you build wealth by lowering your monthly payment and potentially saving you interest by lowering your interest rate.

Example credit card balances

For example, let's say you have three different credit cards with the following balances:

The total balance is $14,500, with a combined minimum monthly payment of $580. Making only minimum payments of 4% of the balance, it would take 11 years and six months to pay off, and you'd pay over $7,500 in interest.

However, if you take a $14,500 personal loan with an interest rate of 9% for five years, your minimum payment would be $301, and you'd pay $3,560 in interest. This means you'd save $4,276 in interest, and you'd be out of debt six and a half years quicker. This frees up $279 per month in your budget.

You could use those extra funds to pay down your personal loan even quicker. Doing this would save you another $1,942 in interest, and you'd pay the personal loan off in just two years and four months.

Or, you could invest the extra $279 per month. Historically, the stock market earns an average of about 10% per year over long periods of time. If you invested $279 per month for five years while you were paying back the personal loan, you'd have $21,810.

If at that point, you began to invest the full $580 per month for another five years, you'd have $79,530, assuming a 10% return.

Credit score impact

Over the long term, consolidating debt can improve your credit score. There may be a temporary hit due to the hard credit inquiry and a new loan. It may also increase your credit utilization temporarily.

However, if you manage your debt responsibly, you should see improvement over time. On-time payments will positively impact your score, and the impact of a new loan will decrease over time.

Turn savings into earnings

Use the money you save from consolidating high-interest debt to invest or pay down your loan faster.

Home improvements as an investment

You can use a personal loan for home improvements; in fact, some lenders offer personal loans specifically for home improvements.

However, the average personal loan interest rate is about 12%, while the average interest rate for a home equity loan is about 7%. Therefore, you may want to consider a home equity loan or line of credit instead. But if you don't have equity in your home or don't want a home equity loan for any reason, a personal loan will work.

Invest in value-adding projects

Focus loan funds on improvements or ventures that increase your net worth, like home upgrades or proven business inventory.

Also, keep in mind that most home improvements don't recoup more than what was spent, but you do get to enjoy your upgraded home, which can sometimes be worth more than money.

Here are the top ways to add value to your home:

• Upgrading the front door recoups 188% of the money spent.
• Adding stone veneer to the exterior recoups 153% of the money spent.
• A midrange kitchen remodel recoups 96% of the money spent.
• Adding a deck recoups 83% of the money spent.
• A midrange bathroom remodel recoups 74% of the money spent.
• Vinyl window replacements recoup 67% of the money spent.

Starting a business with a personal loan

You can use a personal loan to start a business. However, not all lenders allow funds from personal loans to be used for business expenses, so double-check before choosing a lender. You may also want to consider a small business loan instead.

One advantage of personal loans is that your application will be based on your personal credit and ability to repay, not on the strength of your business. A big disadvantage is that you’re adding an additional liability to your business, which could weaken it in the long run.

What you spend the money on matters. Eric Croak, president of Croak Capital in Toledo Ohio, said: “Honestly, most small businesses do not need more debt. They need margin. That being said … if someone uses a $25,000 personal loan to prebuy discounted inventory with a 20% markup and sells through in 60 days, that is a strategic way to buy time and profit.

“But if they are floating payroll, gambling on ad campaigns, or just filling a gap because the business model is weak, the loan turns into a grenade. I would say personal loans are a tool, not a fix.”

Understanding good debt vs. bad debt

Good debt is debt that is used to improve your financial situation. For example, a mortgage is used to buy an appreciating asset, a house and therefore allows you to increase your net worth over time.

Bad debt is used to purchase something that doesn’t increase your net worth. For example, putting a vacation on a credit card is fun, but it decreases your net worth over time.

A personal loan could be considered either good or bad debt, depending on how you use the funds. If you use it to consolidate debt or grow your business, it could be considered good debt.

Good or bad, any debt requires caution and a plan to pay it off before you sign the loan.

Managing personal loan repayments

You'll want to have a payoff plan before you take on the new loan. Know what you can afford and set up automatic payments to stay on track. If you aren't sure what you can afford on a monthly basis, set up a budget and track your spending for a few months to get an idea of how you’re spending your money.

Croak said, “Treat it like a 90-day mission. Pay more than the minimum. Set aside a specific dollar amount (say $300 per paycheck) and automate it to hit every two weeks. That trims the principal faster, saves hundreds in interest and usually knocks months off the loan term.”

Missing payments can be detrimental to your credit score. Each late payment lowers your credit score and will remain on your report for seven years. It's important to both your finances and your credit score to stay on top of your monthly obligations.

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