Using a Personal Loan for a Security Deposit
Security deposits are a necessary evil of apartment rentals, and not everyone can afford them. That's when a loan for a security deposit may come in handy.
Typically equal to the first month’s rent—or sometimes first and last months’ rent—this amount is usually requested by a landlord in order to guarantee that a tenant will pay rent and properly care for an apartment. If a tenant fails to pay rent or damages, the landlord will keep all or part of the security deposit as compensation.
While security deposits are generally required for most apartments, they can be a huge challenge for many tenants, particularly those who are just starting out. Some landlords may charge as much as three months' rent as a security deposit. Having to put together enough money to pay for both rent and the security deposit can be difficult, which is why some renters might consider security deposit loans.
How Personal Loans Work
The best personal loans involve borrowing money for almost any purpose. You can take out car repair loans, debt consolidation loans, loans for medical expenses, and the list goes on. Because personal loans can be used for just about any purpose, renters can take out security deposit loans.
Personal loans are offered by banks, credit unions, online lenders, and other financial institutions. Applicants are approved based on their credit score and financial history, with lower interest rates and terms offered to applicants with higher credit scores and a better history of paying off their bills on time. Lower rates are also available for applicants who offer collateral for a personal loan, such as a car. These are known as secured loans, discussed in more detail below.
Once the loan is approved, the funds are disbursed, and the borrower can spend the money as he or she desires. Then the borrower will make regular monthly payments to repay the loan.
Types of Security Deposit Loans
There are two main types of personal loans: secured and unsecured. An unsecured loan does not require the borrower to put up collateral (personal property, such as a car) to be approved. As a general rule, borrowers must have good credit to be approved for an unsecured personal loan. In addition, unsecured loans often have higher interest rates than secured personal loans.
Secured personal loans involve the use of collateral. Because the bank will have something to seize in the event that the borrower defaults on the loan, secured loans tend to have lower interest rates. They are usually a better option for people with a bad credit history.
Pros of a Loan for a Security Deposit
There are some advantages to using security deposit loans. For renters with poor credit, a personal loan may improve their credit. Because a personal loan involves making installment payments, it can help a borrower establish a good credit history with each on-time loan payment.
In addition, taking out a personal loan gives renters some financial wiggle room, allowing them the ability to pay their security deposit without depleting their savings. Because personal loans are available in amounts ranging from $1,000 to $50,000, a loan can serve as a financial cushion. It can also help tenants negotiate their rent, as the ability to pay in advance may convince their landlord to reduce their rent and/or their security deposit.
Personal loans are also a better option than higher-cost alternatives, such as payday advance businesses. While personal loans do charge interest, the rates tend to be far lower than those charged by payday advance companies. You can also comparison shop for the best personal loan, making it a better deal for many people who are strapped for cash.
Cons of a Loan for a Security Deposit
Although there are benefits to using security deposit loans, there are downsides as well. Perhaps most importantly, the loan will carry interest—which means that you will be paying more to borrow the money. Depending on how much money you take out, the interest rate, and the loan term, the interest could add a thousand dollars or more to what you owe.
You will also be going into debt in order to pay for a security deposit, which may be a sign that you are unable to live independently. You might end up needing more than what you borrowed, putting you at risk of needing to borrow more—going further into debt—if you cannot handle your finances.
It can also be challenging to get a personal loan if you don’t have an established credit history, which might be the case if you need to borrow money for a security deposit. You may need to have a co-signer for your loan or pay an extremely high interest rate in order to qualify.
Bottom Line
While a personal loan can be used for a security deposit, it probably is not the best idea from a financial standpoint. Personal loans create debt, and when they are being used to rent an apartment, they aren’t building equity. If you need a personal loan for a security deposit, the better idea might be to wait to get an apartment until you can afford the deposit. If you can’t wait, be sure to comparison shop to get the best possible rate.
