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June 30, 2022

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Home improvements, medical bills, vacation? Use of personal loans points to different needs of high and low credit score borrowers

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High incomes and high credit scores don’t always go together, but when they do it’s a powerful combination that banks love.

That’s according to a study by LendingTree that showed people with prime credit take out bigger personal loans — because they’re able to.

The online lender also found there are some significant differences in how borrowers with high credit scores and those with low credit scores use money from personal loans, according to data collected from closed loans on its platform between April 2021 and March 2022.

Borrowers with higher credit scores — 720 or above on a scale of 300 to 850 — were more likely to use personal loans to make a home improvement that would increase the value of their residence or start a small business. On the other hand, lower credit score borrowers often used personal loans to pay medical bills and meet other immediate needs.

“This report is as much about income as it is about credit scores,” said Matt Schulz, chief credit analyst at LendingTree based in Charlotte, North Carolina. “There’s a big difference between taking out a personal loan to make an investment in a house or a business as opposed to using a loan to extend your monthly budget.”

A personal loan is a cash payment that can be used for just about anything. Some lenders will ask borrowers what they intend to do with the money, but no one actually verifies where the money is spent. The bank only cares that it’s paid back on time.

High and low credit score borrowers both take advantage of personal loans to consolidate their consumer debt, but people with lower income and low credit scores more often use borrowed money to cover the gap between their earnings and their basic needs, according to local credit counselors.

“We’ve seen low-income clients use personal loans for things like school tuitions and moving and relocation costs,” said Heather Murray, director of compliance and community relations at South Side-based Advantage Credit Counseling.

Counselors at the nonprofit organization say Pittsburgh area clients have taken out personal loans to pay everything from their quarterly business taxes to expenses that arose due to getting a divorce.

“Now what we’re seeing is higher credit score clients using credit cards more due to the cost of everyday expenses,” Murray said. “ Then they turn to personal loans to consolidate the debt because they can’t stop using the cards.

“Once they get into that scenario, they start reaching out to us,” she said. “Typically when you’re in a place where you’re taking out debt to pay off debts, it usually never works out if you don’t change the behavior.”

When borrowers with high incomes and high credit scores reach a point of taking out personal loans they tend to go big.

High-score borrowers average $18,443 in personal loan amounts, which is a whopping 122.2% higher than the $8,301 average amount taken out by consumers with scores below 720. High score people borrowing for home improvements take out an average of $21,510 in personal loans.

However, the LendingTree study points out the lower dollar amounts taken out by people who fall into a lower income bracket typically aren’t by choice. In many cases, lenders will restrict loan amounts for those with lower credit scores and then offer them extremely high interest rates.

Chris Chaney, a vice president and financial adviser at Fort Pitt Capital Group in Green Tree, said wealthy individuals often prefer to borrow money for home improvements and cars if the loan will allow them to keep their own money invested and working for them.

“Our clients typically have a lot of assets and a lot of options,” Chaney said.

He said his clients — who are typically high net worth — always consult with him before they take on any debt, including personal loans so that he can look at all of their options and make a recommendation.

“I advise clients to use their cheapest money,” Chaney said. “So, if you can borrow money at 1 % or 2% you don’t want to use money you have that could make you more money over time. That’s expensive money.

“It may make more sense to use debt to buy a car and keep your money working,” Chaney said.

Debt consolidation topped the list of uses for personal loans for higher and lower credit score borrowers.

“Personal loans are an amazing tool to help people not only save money but to streamline their finances,” Shulz said. “Dealing with just one debt payment each month rather than four or five separate ones is a pretty big deal, which is why people of all kinds use them that way.”

Lower-score borrowers were more likely to use personal loan proceeds for experiences such as vacations and weddings that are meaningful to the individuals but not likely to generate more future income for the family.

But that could be acceptable in some situations as far as some financial advisers are concerned.

“If a personal unsecured loan is your only option, I guess you gotta do what you gotta do,” said J. Victor Conrad, owner of Pinnacle Financial Strategies in Pine Township.

He said he’s not a fan of personal loans because they tend to come with higher interest rates than home equity lines of credit. His professional experience has been more related to working with clients who use their home equity for loans and securing better rates.

“My 40,000-foot observation is that those with lower credit scores tend to have less secure finances,” Conrad said.

“Using more expensive personal loans for things like these purchases likely only makes their overall financial situation a bit worse — certainly not better and not likely even treading water.”

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