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Although it can be tempting to spend money you get from a personal loan on whatever you want, sometimes that’s not an option—and other times it’s just a bad idea. As flexible as personal loan spending can be, there are a few restrictions and limitations on how the funds can be spent. Here’s a breakdown of things you can't and shouldn’t spend a personal loan on.
1. College Tuition
Using a personal loan to pay for college tuition is, in many cases, both prohibited and inadvisable. Many lenders don’t allow you to spend personal loan funds on college tuition because of the strict regulations required by lenders under the 2008 Higher Education Opportunity Act.
This legislation stipulates that when a lender provides a loan for private education, they must provide certain disclosures, allow for a 30-day rumination period, and allow borrowers to cancel the loan within three days of fund dispersal. Plus, the lender can’t be affiliated with the colleges their borrowers are planning to attend.
Many financial institutions simply can’t abide by these regulations. As a result, they don’t allow personal loans to be used for college tuition. Nevertheless, you can use a personal loan for education-related expenses and for other types of tuition such as coding bootcamps—just not to pay for college tuition.
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Instead of using a personal loan to pay for college tuition, a federal student loan offers more advantages. Student loans often have lower interest rates, can be borrowed at larger amounts, and the loan is repaid upon graduation rather than immediately.
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For some people, gambling is both a form of entertainment and a source of income. But, regardless of how successful a gambler you are, using a personal loan to support your gambling activities is strictly prohibited by many lenders.
3. Down Payment on a Home
Not only is qualifying for a decent mortgage hard, but coming up with a cash down payment is one of the biggest obstacles for families. You may think you can take out a personal loan as the down payment and repay it over time, but conventional mortgage lenders and FHA lenders do not allow personal loans as down payments.
The reason most mortgage lenders forbid this is because when you take out a loan, you assume a debt obligation. If you were to take out a mortgage and a personal loan, you'd have dual debt obligations that can stress your finances. This creates a lot of risk for the lender, and they'll see you as less likely to repay their home loan.
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There's no magic bullet to saving. It takes time and hard work to be able to build up a down payment fund.
Here are some tips that can help:
- Pay off high-interest debt: If you have credit card debt, consider a debt consolidation loan so you can cut down on your interest payments overall. Once you're free of debt, you'll have more money to put into your savings.
- Cut down on unnecessary expenses: Evaluate where you are spending your money and how you can cut expenses. Whether it is opting for a cheaper vacation or not buying an extra TV you don't need, find areas where you can trim unnecessary costs.
- Create a savings fund: Consider depositing monthly into a high-yield savings account to build up your savings. You'd be pleasantly surprised how much more interest you can earn compared to a traditional savings account.
4. Business Expenses
Some lenders allow you to use a personal loan for small businesses, while others don’t. Whether the lender allows it or not, there are several risks involved in using a personal loan for business expenses.
There are a couple of reasons why a personal loan for business expenses might not be a good idea:
- You could be personally liable for the debt if your business fails and you cannot repay the loan.
- You won't build business credit since the loan will be in your name.
- Personal loans have lower borrowing limits than business loans.
So you might reconsider using a personal loan to power your venture and instead look at small business loans, where you can actually build business credit and access higher loan amounts at lower rates.
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It's not advisable to use funds from a personal loan to make investments. Depending on the type of investment, the risks can be high and if the investment fails, you're on the hook for repaying the loan without any benefits in return.
Investments such as the following are often considered too risky for a personal loan:
- Buying stocks
- Investing in cryptocurrency
- Buying foreign currencies
- Investing in commodities
Not only would it be financially unsound to put your funds toward these kinds of investments, but it may violate some lenders' policies.
6. Recurring Monthly Expenses
If you find yourself short on rent every month or can't pay your basic monthly bills, taking out a personal loan will not be a cure for your financial struggles. Personal loans can make sense if you're facing a temporary hardship and need a little bit of money to get back on your feet. But taking out a loan you already can't afford just to cover your bills could be putting yourself deeper in debt.
Instead, look for hardship programs that can provide financial assistance for rent, utilities, or other types of bill. Or, find a way to increase your income through side hustles.
Do Your Research
A personal loan can be useful in many situations, but it may not make sense in all scenarios. The key is to do your research and make the best decision for your situation. Always shop around, compare interest rates and repayment terms, and read the fine print for any fees that can add to your borrowing costs.
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Many times, no, a bank will not investigate how you spend the money they give you via a personal loan. But if they have reason to suspect you’re violating any of the terms of your loan agreement, they have the right to take action.
Some lenders may not take any action at all, while others may force you to repay the full loan plus interest immediately if you are in violation of the loan agreement. Double check with your lender to fully understand what is prohibited and the terms of your loan's usage.
Yes, when you apply for the loan, the lender will require that you state the purpose of the loan. The loan purpose will affect your rates, loan terms, and amount you are eligible to borrow.
You can repay a loan using the same funds you borrowed, but you will still be liable for the interest payments and origination fees. Some lenders may charge a prepayment penalty fee, so double check with your lender's terms and rules.