Another workday afternoon is crawling along when your phone chimes a most welcome interruption. It’s your closest friend announcing by group text the details of her long-awaited, much-buzzed-about birthday bash – a week-long stay at an all-inclusive resort in the Caribbean.
You immediately mark your calendar and save the date.
Then, reality sinks in. You don’t need to check your bank account or open your budgeting app to know that you’ll never be able to afford a trip like this. Not anytime soon, at least. Plus, this particular party is just a few months away.
Are your dreams dashed? Maybe not. You know it’s not wise to rack up vacation-related credit card charges, but what if you had a cheaper borrowing option at your disposal?
In this post, we’ll take a closer look at the mechanics of using a personal loan to fund a vacation of any kind – be it a destination birthday bash, a far-flung wedding, or a family trip up to the lake. Check out the list below for the advantages of taking out a personal loan for vacation, along with a litany of reasons why doing so may not be right for everyone.
How Vacation Loans Work
A vacation loan is a personal loan taken out to fund vacation-related expenses. Structurally, it’s no different than a personal loan you might take out for any other permissible purpose, such as debt consolidation, home improvement expenses, wedding expenses or business startup expenses.
What to Expect From Your Vacation Loan
Personal loan rates and terms vary widely by lender and borrower. For qualified borrowers, secured and unsecured personal loans generally carry lower annual percentage rates (APRs) than premium cash-back or travel rewards credit cards. Over the likely three-to-five-year term of your loan, that could add up to thousands of dollars in interest charges. Generally, well-qualified borrowers with excellent credit – FICO scores above 720 to 740 – can expect to qualify for personal loans with:
- Origination fees under 2%
- Rates under 8% to 12% APR, including the origination fee
- Terms as long as seven years, though five is a more common maximum
Borrowers with good credit – FICO scores above 660 to 680 – can expect to qualify for personal loans with:
- Origination fees under 4%
- Rates under 15%, including the origination fee
- Terms of three to five years
Less qualified borrowers can expect higher rates and fees, coupled with shorter repayment terms.
Shop Around for Vacation Loans
Every lender is different. Some specialize in borrowers with fair or impaired credit, while others restrict lending to borrowers with excellent credit only.
Your credit profile and financial position notwithstanding, it’s in your best interest (pun intended) to shop around with as many lenders as you can manage. In most cases, checking your rate and soliciting loan offers won’t affect your credit score. Lenders only “pull” your credit – which temporarily decreases your credit score and shows up in your credit history – when you formally apply for a loan. If you’ve been truthful and forthright in your initial inquiry, this may only need to happen once.
Moreover, for credit-scoring purposes, all loan applications that occur within a defined period of time (generally at least two weeks) are considered part of the same application process and produce just one credit report entry.
Seemingly small differences in rates and loan terms can dramatically affect your loan’s cost and monthly payment. For example, here’s how your monthly payment and total financing cost on a $5,000 vacation loan could change with different loan APR rates and terms:
- 8% APR and 36-Month Term: This term makes for a monthly payment of $156.68 and total interest charges of $640.55. Push the term to 60 months, and you’re looking at a monthly payment of $101.38 and total interest charges of $1,082.92.
- 11% APR and 60-Month Term: This term equates to a monthly payment of $108.71 and total interest charges of $1,522.73. Dial the term back to 36 months, and you’re looking at a monthly payment of $163.69 with total interest charges of $892.97.
- 14% APR and 36-Month Term: This term results in a monthly payment of $170.89 and total interest charges of $1,151.97. Push the term to 60 months, and you’re looking at a monthly payment of $116.34 and total interest charges of $1,980.48.
- 17% APR and 60-Month Term: This term results in a monthly payment of $124.26 and total interest charges of $2,455.77. Dial the term back to 36 months, and you’re looking at a monthly payment of $178.26 and total interest charges of $1,417.49.
Without accounting for interest rate variation, shorter terms generate lower total interest charges and higher monthly payments. Longer terms produce higher total interest charges and lower monthly installments.
If you don’t want to check rates and terms with multiple lenders individually, consider an aggregator like Fiona. Fiona delivers personalized loan rates from up to 11 online lenders in just two minutes.
How to Use Your Vacation Loan
You have two options to dispose of your vacation loan’s proceeds:
- Pay Vacation Expenses Directly. In this scenario, your loan is funded before you make your first vacation-related purchase. You hold the loan’s proceeds in a checking account and use your debit card to pay for vacation expenses as they accrue – first for airfare and hotel reservations, and then for day-to-day expenses on the ground.
- Pay Off Vacation-Related Credit Card Charges Before They Accrue Interest. In this scenario, you may use a rewards credit card to make initial purchases a few days before your loan is approved, such as airfare, hotel reservations, and other items that need to be reserved well in advance. Moving forward, you’ll use your credit card to cover vacation expenses as they arise.
In all cases, you immediately pay off your credit card balances before they begin to accrue interest.
The advantage of this strategy is the opportunity to capitalize on credit card rewards. The drawback of making any purchases before your loan funds arrive is that you run the risk that your application will be denied.
Pros of Using a Personal Loan for Vacation
Don’t expect anyone who is acting in your best financial interest to recommend that you take out a personal loan to fund discretionary travel. Instead, expect them to tick off a long list of more responsible uses for your precious borrowing power – or to wave you off borrowing to fund discretionary expenses entirely.
That said, using a personal loan for vacation does have benefits, and there’s a small chance that a well-timed vacation loan could reduce your total travel costs. Here are some potential benefits of taking out a personal loan for your next vacation:
1. You Don’t Need to Save for Time-Sensitive Trips
The more expensive the vacation is, the longer you’ll need to save up in advance. Putting your vacation expenses on credit eliminates the need to wait.
Of course, for truly voluntary leisure trips, the most fiscally responsible course of action is to defer trip-related purchases until you’ve saved enough money to pay for them. However, this isn’t always an option, especially for time-sensitive trips that you’d rather not miss. For instance, you likely won’t have more than a few months to plan for:
- Attending a friend’s destination wedding for which you received only a formal invitation and not an earlier “save the date” invite
- Visiting a close family member who is recovering from a major surgery
- Welcoming a close family member’s baby
- Taking a “babymoon” couples’ getaway before you or your partner give birth
- Visiting a potential adoptee’s birth parents or custodians
2. You’ll Have Funds Ready for Opportunistic Purchases
With your loan’s funding on hand, you’ll be ready to take advantage of temporary price drops, flash sales, and limited-time package deals.
On an expensive trip – say an international vacation for which the cost of round-trip economy airfare alone might exceed $1,000 per person – this strategy could reduce your travel costs by hundreds of dollars. Though unlikely, it’s possible for your cumulative savings on well-timed purchases to match or exceed the total financing costs on a low-interest, shorter-term loan.
3. You Won’t Miss Out on Potentially Priceless Memories
Leisure travel is all about making memories. Only you can determine what qualifies as “memorable,” but some or all of the time-sensitive ideas above probably meet your standards. The same is true for our hypothetical destination birthday bash, and perhaps a close friend’s destination bachelor or bachelorette party.
Don’t overlook rare opportunities. For example, in August 2017, several thousand Americans traveled great distances to meet the path of the first coast-to-coast total solar eclipse in 99 years, according to Space.com. Many camped outdoors in the 70-mile-wide, mostly rural swathe, which extended from Oregon to South Carolina; others slept in recreational vehicles. Those not willing or able to do either were forced to pay exorbitant prices for hotel and short-term rental accommodations. Even the humblest motels sold out along the entire arc of totality, where the sun was completely blacked out. This is a powerful suggestion that humans will go to great lengths to make lasting memories.
4. It May Be Cheaper Than Charging Your Credit Card
If you have a credit card with a sufficiently high spending limit, you can, of course, charge vacation expenses to your card and carry a balance from month to month until the trip is fully paid off.
However, unless you qualify for a 0% APR introductory purchase promotion or have a very low regular APR, this option is almost always more expensive than using a personal loan. Additionally, it’s never advisable for discretionary expenses, even if they are expenses you’d rather not do without.
Cons of Using a Personal Loan for Vacation
It’s important to reiterate that under normal circumstances, you should not use a personal loan for vacation. In some cases, personal loans are useful and can even be beneficial. However, they are rarely a wise decision for discretionary travel. Here’s why:
1. It Could Impact Your Creditworthiness
Taking out a loan may negatively impact your credit score and dampen your appeal to lenders.
The most significant risk of lowering your credit score is the potential for missed payments. If your financial situation changes for the worse during your loan’s term and you’re unable to make your monthly payment, your lender may issue an adverse report to the three major credit reporting bureaus. With payment history information remaining on your credit report for seven years under normal circumstances, missing even a single loan payment may have significant long-term credit consequences.
Separately, adding a major new credit account increases your debt-to-income ratio (DTI). Although this ratio doesn’t directly affect your credit score, it is an important consideration for lenders. Mortgage lenders generally don’t originate loans to borrowers with DTI ratios above 43%, and some personal lenders cut off applicants at 40% DTI.
2. You Can’t Avoid Interest Charges
When you pay off your credit card in full before your statement due date, you avoid interest charges entirely.
Personal loans don’t work that way. Every payment includes principal (the initial loan amount) and interest. To see the precise mix on any given payment, you can consult the loan’s amortization schedule. Making additional principal payments or paying off the loan in full ahead of schedule will reduce the loan’s total financing cost relative to the amortization schedule, but neither eliminates your interest obligation.
3. You May Need to Put Up Collateral
If you have strong credit, you’ll likely qualify for an unsecured personal loan with an affordable interest rate, a low or nonexistent origination fee, and a favorable term.
However, if you have mediocre or bad credit, you may find yourself choosing between an unsecured loan with an APR that matches or exceeds that of your credit card or a more affordable secured loan that requires you to put up your vehicle title as collateral.
Falling behind on your secured loan payments isn’t just bad for your credit. Should you become seriously delinquent – 90 days or longer – your lender could move to seize your collateral.
4. You’re Probably Not Investing in Yourself or Your Assets
With possible exceptions, even a well-deserved vacation does not qualify as an investment in oneself or one’s assets. However, a home improvement project that’s likely to increase your home’s resale value does qualify as a value-enhancing investment. Or, a concerted effort to consolidate existing high-interest debts, which could dramatically reduce your long-term financing costs, is another example of a value-enhancing investment.
5. Repayment Will Impact Your Budget for Years
Assuming your budget doesn’t allow for full early repayment, taking out a personal loan represents a commitment of at least three to five years. That’s 36 to 60 months of subtracting your loan payment from your discretionary budget.
This commitment shouldn’t be taken lightly. For instance, the lowest-cost loan example above – 8% APR for 36 months – produces a monthly payment of $156.68. For a borrower taking home $2,000 per month after withholding taxes, that’s nearly 8% of their income. For a borrower netting $3,000 per month, that’s over 5% of their income.
6. It May Encourage Bad Financial Habits
Even if you’re able to pay off your vacation loan on or ahead of schedule without adversely impacting your budget, the experience could prove to be a net negative for your long-term financial health.
Having financed one major discretionary purchase on credit, you may be less reticent to do so in the future, and consequently, you might be more vulnerable to financial distress attributable to some future loan. Constantly carrying installment debt may also keep you from building your long-term savings or contributing regularly to a retirement account.
Alternatives to Using a Personal Loan for Vacation
If you think you have to decide between taking a fantastic vacation and being debt-free, you don’t. Having the former without the latter is possible.
If you determine that it’s not in your best interest to use a personal loan to fund your next vacation, consider these alternatives:
1. Start a Vacation Savings Fund
Even on a modest budget, it’s easier than you think to save for your next vacation, especially if you prepare in advance.
Start by estimating the total cost of your planned vacation. That’s what you’d need to borrow, assuming that you don’t contribute any savings.
Then, solicit loan quotes from at least six lenders to get a sense of what you’ll qualify for. Choose the loan that best fits your time horizon, with a payment that fits your monthly budget. If your budget can accommodate that payment for the loan’s full term, you can afford to put that amount away each month until you’ve put away the total cost of your vacation.
Since your loan payment includes interest, you’ll reach your savings target sooner than you’d need to pay off the loan. However, if you’d rather not wait two or three years to top off your vacation savings account, you can always raise your monthly contribution and look for fat to trim from your budget elsewhere.
2. Temporarily Defer Nonessential Travel
Deferring ambitious travel plans doesn’t mean embracing life as a hermit. Nor should it stop you from making regular contributions to a vacation fund.
It does mean prioritizing essential or particularly meaningful trips, such as close friends’ or family members’ weddings, family reunions, or once-in-a-lifetime cultural exchange opportunities.
3. Plan for a Frugal Vacation
If you’re not willing to compromise on your nonessential vacation’s duration or destination, look for every opportunity to save money on your vacation. After all, trimming travel costs wherever possible should already be a top priority.
Savings opportunities vary by itinerary. Consider these frugal summer vacation ideas:
- Camping in rented tents at free campsites close to home
- Renting a cozy house and going all-out on home-cooked meals
- Grabbing an off-season hostel deal in your favorite North American or European city
- Backpacking in lower-cost destinations, such as Latin America or Southeast Asia
If you use a travel rewards credit card, you can subsidize the cost of your vacation by cashing in points to cover airfare, hotel, car rental, and incidental expenses.
Look for opportunities to boost your points’ redemption value. For instance, you can take advantage of generous point transfer offers or cash in on proportionally expensive overseas flights.
4. Monetize Your Travel
The surest way to reduce the cost of your next vacation is to monetize the experience.
For example, if you regularly travel for business, you’ve probably appended a leisure day or two to a scheduled business trip. The limiting factors here are your paid time off allowance, and whatever obligations await you at home.
If you have more discretion over your business travel activities – say, you own a company, or you’re relatively high up in your organization – you can more explicitly mix work and leisure in destinations where your organization operates or has intentions of doing business.
If you’re a freelancer or solopreneur, or if you have a talent that aligns with your passion for travel, you can monetize your travels on an ad hoc basis. I subsidized a recent trip to Thailand, for instance, by devoting the bulk of the trip to researching and writing guides about sightseeing in Bangkok and traveling to Thailand on a budget. Without that monetization opportunity, I wouldn’t have been able to spend nearly two weeks on the other side of the world.
5. Raise Funds From Friends and Family
Under the right circumstances, consider turning to your extended personal network to subsidize your travel costs.
Context is important. Don’t bother wasting resources on a crowdfunding campaign for your run-of-the-mill weekend getaway; you won’t get many takers anyway. Save your ask for extraordinary plans, such as a destination honeymoon.
Honeymoon registries are increasingly popular. Many newlyweds would prefer wedding guests to subsidize an unforgettable overseas adventure, rather than load them up with home goods they’ll never use.
6. Tap Into a Secured Credit Line
If you have access to a low-interest secured credit line, such as a home equity line of credit (HELOC) through an online lender (we’re partial to Figure.com), tap into it before you take out an unsecured vacation loan. HELOCs invariably carry lower interest rates than unsecured loans, which means lower total financing costs. Here’s what that looks like:
- On a $5,000 HELOC draw at 4.5% APR, paid off over 36 months, you’ll have a monthly payment of $148.73 and total interest charges of $354.45.
- On a $5,000 unsecured personal loan at 14% APR, paid off over 36 months, you’ll have a monthly payment of $170.89 and total interest charges of $1,151.97.
That’s a difference of $22.16 per month and $797.52 in total interest over the 36-month term.
Everyone deserves a break, but at what cost? If your financial situation happens to change for the worse and you’ve taken on new debt to fund a wholly discretionary vacation, the deficit could have serious, long-lasting consequences for your credit and personal finances.
If your heart is set on taking a vacation soon, consider using your personal loan to pay off existing high-interest credit card debt, if you have any, and put the savings into a travel fund. In doing so, you’ll have more peace of mind, and you’ll set yourself up for higher chances of financial success in the long term.
Are you considering taking out a personal loan to fund your next vacation? Why or why not?