Does the Reason for Your Personal Loan Matter?

When you take out a personal loan, the lender will typically ask you how you intend to use the funds. It does this for many reasons, most of which revolve around compliance, but also to ensure you’re taking out the best loan for your needs. 

Once a personal loan is fully funded, borrowers are usually free to spend the money as they see fit, but exceptions exist. Keep reading to find out the best reasons for a personal loan and why some purposes are better than others.

Why do lenders ask the reason for a personal loan? 

Lenders are bound by laws and regulations intended to protect consumers and the financial industry. When a lender inquires how you intend to use the money from a personal loan, part of the reason it must ask is for compliance with these laws and regulations. 

Another reason it must ask to verify you’re not using the loan for illegal activities.

Your loan purpose can also influence the rate you get. If you plan to use the loan to consolidate debt, as opposed to covering wedding expenses, getting a different rate is possible.

Many lenders ask for the loan purpose by getting borrowers to click on how they intend to use it by providing numerous options, but all are personal loans.

Some lenders also have internal regulations. Happy Money, for example, only provides loans to borrowers consolidating credit card debt. While this exclusivity is rare among lenders, it’s something to remember as you rate shop. 

Also, if you’re consolidating debt, just know that the underwriting process will likely involve the lender looking at your credit reports. 

Lastly, the purpose of a personal loan is only one factor when determining a loan’s interest rate. Other variables include your credit score, income, and debt-to-income ratio. Your chosen loan term, and whether any collateral is needed, also influences your rate. 

Do lenders verify what borrowers use the funds for?

After the loan has been disbursed, most lenders do not verify that borrowers use the funds for what they stated they would. However, there may be exceptions, particularly for home renovation or debt consolidation loans.

If you’re taking out a loan to pay off debt, some lenders will pay off the debts on your behalf. Others may verify that you have as much debt as you say. Not all personal loans work the same way. To understand how a personal loan works, you may need to speak with a loan officer. 

On the other hand, lenders offering home renovation loans may require estimates from contractors and building supply companies. If a loan has unique requirements, it’s a safe bet that it will be disclosed to you before signing the loan agreement. 

Ask the expert

Rand Millwood

CFP®

Typically you would want to consider what benefits you gain by taking out a loan. It should increase value (i.e., home renovations), improve earning potential, reduce debt, or reduce monthly cash flow outlay. If the loan you are considering does not accomplish one of these, you should strongly evaluate whether these are funds you should be spending versus not.

Best reasons for personal loan

A personal loan can be used for almost anything, but some reasons are better than others. Overall, there are three categories for personal loan uses:

✅ Recommended

❌ Not recommended

🚫 Prohibited

Here’s a list of how we’d categorize common expenses within those three buckets. 

Reason	Recommended?
Debt consolidation	✅
Home renovation	✅
Education/professional development	✅
Medical Expenses	✅
Moving	✅
Small business expenses	✅
Vacation	❌
Wedding Costs	❌
Down payment for a new home	❌
New car	❌
Luxury purchases	❌
Day trading	❌
Gambling	🚫
Illegal activities	🚫

Debt consolidation

Consolidating your debts with a personal loan could save you money in interest. Because of this, it is likely to improve your financial position. 

Out of everything on this list, it’s the best reason for a personal loan because it can improve your finances and credit score.  

Home renovation

Renovating your home with a personal loan does two things: it improves your quality of life and, should you decide to sell, it is likely to improve your financial status because of the return on investment (ROI). While it may not be number one on this list, it’s a close second.

Education/professional development

Any training or courses you can take that will qualify you for a raise or higher paying job is a smart use of money. However, remember that your employer may pay for higher education or a student loan may be a better fit. Compare loan terms and interest rates to see which fits you and your needs better.

Medical expenses

Medical procedures that improve your quality of life are a good reason to take out a personal loan. A personal loan may also be a good idea if you have existing medical bills. However, before you take out a personal loan to pay for medical debts, contact the healthcare provider first. 

Many are willing to set up low or zero-interest payment plans. Just ensure you understand whether there are additional charges you need to be aware of before agreeing to a payment plan.

Moving

You don’t have to move far away from your current home for moving costs to add up. If you’re changing locations for a job that will offer you higher pay, taking out a personal loan to pay for moving costs could be wise, especially if you haven’t received your first paycheck to cover costs upfront. 

Small business expenses

It can take a while to qualify for a small business loan, and one way around that is to use credit cards and personal loans in the interim. While not every lender is willing to approve a personal loan for starting a small business, the loan could be used to improve your financial position. 

A personal loan may be a good idea as long as you can safely cover the monthly payments, and the loan itself isn’t a gamble for your business’s long-term success.

Vacation

We do not recommend using a personal loan to pay for vacation costs. There is no return on investment and it won’t improve your everyday quality of life. It’s best to take the monthly payments you would make on a vacation loan and store them away into savings. 

Wedding costs

Wedding expenses are another type of personal loan frequently advertised by lenders. While weddings are a significant event in a person’s life, they don’t improve your financial status or quality of life. If you feel a personal loan is warranted, try to borrow only the bare minimum. 

Down payment for a new home

Down payments are supposed to come from your savings and are another way of showing financial responsibility to mortgage lenders. If that money comes from a personal loan, you’re showing just the opposite. Many lenders will not accept the money from a personal loan as a down payment. FHA loans strictly forbid it.

New car

Using a personal loan to purchase a new car is generally a bad idea. Personal loans are often unsecured, with higher interest rates than auto loans. Auto loans, conversely, are secured with the car you purchase and have lower interest rates as a result. 

Luxury purchase

Using a personal loan to purchase a luxury item, which, in this case, is anything that is unnecessary for your day-to-day life, is rarely a good idea. Only debt that improves your financial position is good. 

Day trading

Any day trading or speculative investment is generally a bad use for a personal loan. Even if you feel very confident in the investment, the truth is that you never know. 

Gambling

Legal gambling should only ever be done with spare cash, but even then, we’d argue putting the money into an investment account is a better idea.

Illegal activities

Using a personal loan to fund illegal activities is a top-tier no. This is true across all lenders.

What is the best reason to give when applying for a personal loan?

We’ve established there are good reasons to go into debt, as well as bad reasons. So, what should you put on your loan application? Here are a few of the top uses:

• Debt consolidation: A good reason to take on a personal loan is when the debt will improve your financial position. Therefore, using a personal loan to consolidate your current balances into one with a lower interest rate is probably the best, but there are others.
• Home renovations or updates: Renovating or updating your home often increases its value. Should you decide to sell, the renovations may bring in a higher return than the amount you put in. Because of this, lenders often view home improvement personal loans as a good investment for the borrower.
• Investing in professional development: Whether it’s training or adult education courses, this is also often viewed favorably by lenders. Because those courses may make you more money, lenders may be more likely to approve the loan if you have a good income and credit score.   

Alternatives to a personal loan 

Personal loans provide convenient access to funds for diverse needs. Still, if you’re reconsidering because your loan would be for a purpose we don’t recommend or that the lender prohibits, these options might be more suited to some situations.

Savings

Self-financing through savings nets zero interest, a significant advantage over a personal loan. 

Drawback: You could deplete savings, which might not be easy to replenish.

Specialized loans

These generally offer better terms—for example, auto loans tend to have lower interest rates than personal loans. 

Drawback: They are purpose-restricted.

Credit cards 

Useful for small, short-term needs, often offering reward programs. 

Drawback: Higher interest rates than personal loans if balances aren’t paid in full monthly.

Payment plans or layaway

A terrific option for purchases from specific retailers or service providers, they may offer interest-free options. 

Drawback: They are also purpose-specific.

Crowdfunding or fundraising

Raise money without the obligation to repay. 

Drawback: Success depends on the appeal of your cause.

Grants and scholarships

Ideal for educational expenses because they don’t require repayment. 

Drawback: Often competitive, and you may need to meet specific criteria.

Family and friends

Usually offer flexible repayment terms. 

Drawback: Lending money can strain relationships.

Financial assistance programs

Many governments and nonprofits offer assistance programs for individuals in specific situations. 

Drawback: Not everyone will qualify for these programs.

FAQ 

Can lenders actually verify how you use your personal loan funds?

Lenders inquire about the purpose of personal loans during the application process, but they typically don’t verify how the funds are used after disbursement. However, if the lender believes funds are being misused, it may choose to investigate.

Are there any legal repercussions for misusing personal loan funds?

Misusing loan funds can have significant consequences, especially if the loan agreement specifies a clear usage. Violating terms could increase interest rates, penalties, and even legal action. Always read the loan agreement to ensure you understand the stipulations.

What happens if I apply for a personal loan for a reason that is not recommended or is prohibited?

Lenders may refuse your application if the loan purpose is not permitted. For example, if you disclose that the loan is for gambling or speculative investments, many lenders will not approve. 

Lenders might view your application negatively if you don’t specify a purpose, affecting your approval chances.

Can specifying a certain use for my personal loan improve my chances of approval?

Yes, this can reassure lenders that you plan to use the loan responsibly. Lenders tend to view loans for debt consolidation, home improvements, or emergencies favorably.

How do lenders decide which loan purposes to recommend, discourage, or prohibit?

Lenders assess risk when deciding which loan purposes to approve or discourage. Purposes that indicate a poor financial decision or significantly increase the risk of default may be disapproved. Regulations also influence what loan purposes lenders can accept.

What should I do if my personal loan purpose doesn’t fit into any of the categories lenders ask about?

If your loan purpose doesn’t fit into standard categories, discuss it with potential lenders before applying. Open dialogue will help you understand whether your loan purpose is acceptable to lenders, mitigating the risk of application rejection.