Why people take out personal loans

Personal loans offer people a simple, structured way to borrow. But what do most of us use them for? New figures from Halifax reveal all…

Personal loans are financial products with a very consistent appeal. Despite the fact that the rates charged on personal loans have risen since the credit crunch hit, they're still a popular way to borrow.

In my view, this is because personal loans generally offer fixed interest rates and require borrowers to commit to structured repayments - unlike the vast majority of credit cards.

In other words, as long as you understand the terms and conditions of your personal loan when you take it out, you should have the security of knowing how much it's going to cost you and how long it will take to pay back in full.

Nosey neighbours
Like many Brits, I'm a bit of a nosey parker - so I was intrigued by Halifax's recently released Annual Loans Review.

In it, the lender reveals the reasons why consumers take out personal loans and how they use the money they borrow. Its figures are based on Halifax personal loan approvals for the 12 months from January to December 2008.

Here, I'll run through the most popular reasons for taking out personal loans, according to Halifax. In addition, I'll provide my top tips for using them as cleverly as possible.

1. Debt consolidation
According to Halifax's study, 54% of customers who took out its loans last year intended to use them for debt consolidation.

Debt consolidation is the process of paying off existing debts (which may be spread across credit cards, store cards, overdrafts and other loans) by borrowing a new lump sum.

Balance transfer credit cards and personal loans are often chosen for this purpose because the interest rates attached to them may be lower than those charged elsewhere. For example, many credit cards charge standard APRs of around 17%, while owing money on a store card might cost you a whopping 30% APR!

On the other hand, the market's best personal loan rates hover at around 8%. By paying off expensive debts with a loan at a rate like this, you could save a serious sum during the lifetime of your borrowing.

However, it's important to ensure you don't consolidate debts just for the sake of it. If you have debt on a loan or credit card that is already at a low rate of interest, be careful not to shift it to a new loan that will cost you more.

Finally, if you do use a personal loan for this purpose, be careful to ensure you've made a budget you can stick to before taking it out.

Remember, the biggest mistake made by some people who consolidate debts is that they spend on their cleared credit cards again. If you do this, you could end up in far deeper debt trouble than you were before.

2. Buying a new or used car
Next on Halifax's list were people taking out personal loans to buy new or used cars. Almost a quarter of customers approved for personal loans from the bank (23%) intended to use them for this purpose.

If you're considering doing the same, it's a good idea to shop around for the best loan rate you can find. The garage you buy from may offer you a finance deal, but it's important to ensure this can't be beaten elsewhere before signing on the dotted line.

In addition, make sure you're comparing like with like when it comes to rates; some garages prefer to quote 'flat' interest rates rather than APRs, which make loan rates look far lower than they really are.

Right now, Alliance & Leicester is offering a market-leading personal loan at 7.9% APR, while Sainsbury's is offering loans at a rate of 8.1% APR.

3. Home improvements
Thanks to declining house prices and the shortage of mortgage finance for anyone without a minimum 25% deposit, home improving seems to have become the 'new' moving.

According to Halifax, 15% of successful loan applications were inspired by the desire to brighten up bedrooms, bathrooms and kitchens across the land.

If you're considering taking out a loan for home improvements, it's a good idea to budget carefully for the work you'll be doing before filling in an application.

Furthermore, it's important to be aware that not all home improvements will add significantly to the value of your property.

If you intend for the work you do to increase what your home is worth, ensure you fully research how your improvements will affect its resale price.

4. Investing in the future
Halifax says its data also revealed that many people use personal loans to pay for investments in their future.

A number of its customers used loans to pay for education and training, such as driving instructor courses and Corgi examination or registration.

If you're thinking of using a loan in this way, ensure you only borrow as much as you need and budget for the repayments you'll need to make while you are studying.

This is especially important if your working hours (and therefore your income) will be restricted during your course.

5. Stranger spending
Finally, Halifax also revealed some of the weird - and not always wonderful - reasons behind a few of its personal loan applications.

Odd approvals included loans for false teeth, cattle (yes, cows!), the publication of an individual's memoirs and the purchase of a mobile disco!

Of course, these items may have been essential for the people that borrowed to buy them.

However, I think some of the stranger things on this list should bring home the message that it's never wise to borrow unless you absolutely need to.

A personal loan can be an incredibly useful tool for helping you achieve a goal, enhance your lifestyle or dig yourself out of a debt hole, provided it's used wisely.

Unplanned or unnecessary borrowing, on the other hand, is a sure way to put serious pressure on your budget.

So, I suppose I won't be publishing my own memoirs any time soon…