Here’s why the purpose of your personal loan matters

While personal loans can be used for a wide range of purposes, lenders typically ask about your intended use of the funds — and that information plays a bigger role than you might realize.

Your reason for borrowing can impact not only your chances of approval but also your loan amount, interest rate, and repayment terms. Here’s more on how the purpose of your loan can affect the borrowing process.

While you can use a personal loan for almost anything, there are some restrictions. That’s why lenders ask what you plan to use the loan for: They want to ensure your intended purpose fits within their guidelines.

If you plan to use the loan for a prohibited purpose, such as gambling or college tuition, the lender will almost certainly deny your application. However, if you plan to use the loan for home renovations, consolidating debt, or financing a wedding, to name a few examples, the lender shouldn’t have a problem with it.

Your loan purpose also helps lenders figure out the best way to structure your loan, including how much you can borrow, your interest rate, and how long you’ll have to repay it. In some cases, they may request documentation or cost estimates to make sure everything lines up.

It’s important to be honest about your loan purpose during the application process. Misrepresenting how you intend to use the funds could violate your loan agreement and potentially result in legal consequences.

Your plan for using a personal loan can impact the borrowing process in several ways. Here’s how.

First, you must plan to use the loan for an approved purpose, such as financing a large expense, paying for home improvements, or consolidating debt. If you’d like to use the loan for a restricted or prohibited purpose, the lender will deny your application.

Additionally, some lenders offer personal loans for specific purposes only. Online lender Happy Money, for example, designs its loans for debt consolidation. You’d need to look elsewhere if you need a personal loan for a purpose other than this.

The way you plan to use your personal loan may also impact how much you can borrow.

If you’re using the loan for a major home renovation, for example, you may be eligible for as much as $100,000, depending on the lender and your credit. It’s not uncommon for major home projects to cost tens of thousands of dollars, and the investment can actually pay off if the updates increase your home’s value.

If your reason for borrowing comes with a clear, defined cost — for example, you want to consolidate $20,000 of credit card debt or pay off $8,000 in medical bills — the lender may also size their loan approval to match.

However, if you’re looking to finance a vacation, wedding, or other nonessential expense, you’ll likely be limited to a lower loan amount.

Read more: Good debt vs. bad debt

Your loan purpose may also affect your interest rate and eligibility for any potential discounts. Upgrade, for example, offers its lowest rates if you use a portion of your loan to consolidate existing debts. If you’re using the loan to purchase an appliance, you wouldn’t qualify for this lowest rate.

Loans for purposes that improve your financial position may also come with lower rates. Your interest rate for a debt consolidation loan may be better than a loan borrowed for a luxury purchase, for instance.

Note that your loan purpose isn’t the only thing that can impact your interest rate. Other major factors include your credit, income, and chosen repayment term.

Your reason for borrowing a personal loan could influence your repayment terms, too. For instance, online lender Lightstream offers repayment terms from 24 to 240 months, depending on the loan type.

Lenders may offer longer terms for purposes that require higher loan amounts (for example, medical procedures or home projects) to keep monthly payments manageable. For discretionary or nonessential uses like travel or shopping, lenders may require shorter repayment periods. Shorter terms reduce the lender’s risk because the loan is paid back more quickly.

When choosing your loan term, consider that a longer term may result in more affordable monthly payments but higher overall interest costs.

Personal loans are flexible by design, so you can use them for a variety of expenses. Some common uses include:

• Debt consolidation

• Home improvements and repairs

• Medical or veterinary bills

• Car repairs

• Weddings and vacations

• Large purchases, such as appliances or boats

• Moving costs

• Fertility treatment or adoption costs

• Emergency expenses

Personal loans can offer fast funding and competitive rates, especially if you have strong credit. You can pay them back with fixed monthly payments over a set period of time.

If you’re considering a personal loan, make sure to use it toward a purpose that aligns with your financial goals. While a personal loan can be a useful financing tool, you also want to avoid taking on unaffordable debt.

There are some limits on how you can use a personal loan. The specific rules may vary by lender, but most restrict or prohibit the following uses:

• Higher education: There are a lot of regulations around education-related lending, so most lenders don’t let you use personal loans for college tuition or related costs, such as paying off student loans.

• Business expenses: A personal loan is designed for personal expenses, so a lender may not let you use one toward business-related costs.

• Down payments: You generally can’t use a personal loan to make a down payment on a house. A mortgage provider will want you to have these funds in savings, rather than debt.

• Gambling or investing: Lenders see this purpose as high-risk and generally don’t permit you to use a personal loan toward speculative investments.

• Illegal activities: This may seem obvious, but you can’t borrow a personal loan for any unlawful purposes.

Having a clear idea of how you intend to use your personal loan can help you find a lender that best suits your needs. Some lenders specialize in debt consolidation, for example, and will send your loan proceeds directly to your creditors to make the process as easy as possible.

Others offer high loan amounts, which may be ideal if you’re embarking on a home renovation project. Plus, some provide rate discounts if you use the loan for a certain purpose or open a checking or savings account when you apply for the loan.

Before picking a lender, make sure to shop around and compare your options. You can often prequalify online, meaning you can check your potential rates without dinging your credit. As you review your offers, look for a loan with low interest rates and monthly payments that work for your budget.

When you’re applying for a personal loan, be honest and up-front about why you need the loan. Your lender must ensure that your intended loan purpose aligns with their rules and regulations. Plus, your lender may shape parts of your loan (amount, interest rate, and repayment term) based on your intended use.

If you change your mind about your loan purpose after applying, contact your lender to discuss your options. The lender may permit you to use the loan for another reason, but it’s best to get their permission before you repurpose the funds.

Getting clear about your reason for the loan can help you choose the right lender and reach your financial goals.

This article was edited by Alicia Hahn.