What Should You Not Use a Loan to Purchase?

Financial loans serve as powerful tools, enabling individuals to achieve significant milestones like purchasing a home or pursuing higher education. However, not all borrowing decisions align with long-term financial health. Using loans for certain types of purchases can lead to considerable financial strain, creating an unsustainable debt burden. Understanding when it is financially sound to borrow is important for maintaining stability and preventing future challenges.

Goods That Rapidly Lose Value

Financing purchases that quickly lose value is generally not advisable because the item’s worth depreciates faster than the loan balance. This situation can lead to negative equity, where the amount owed exceeds the item’s current market value. New vehicles, for instance, begin to lose value the moment they are driven off the lot. A new car can lose approximately 10% of its value in the first month and up to 20% within the first year, often reaching a 60% loss over five years. Similarly, high-end electronics or trendy fashion items also experience swift depreciation. Borrowing for these items means incurring interest charges on something that may soon be obsolete or out of style. Loan obligations can persist long after the item has significantly depreciated or been replaced, creating a prolonged financial commitment without commensurate asset value.

Experiences and Consumables

Using loans for experiences and consumable items, which offer fleeting enjoyment without leaving a lasting asset, is another financially unsound practice. Such purchases include vacations, dining out, concert tickets, or even subscription services. The pleasure derived from these activities is temporary, yet the debt incurred can linger for months or years, accumulating interest. This creates a psychological burden as individuals pay for something they no longer possess or experience. These expenditures are often financed through credit cards, which typically carry high annual percentage rates (APRs). Average credit card APRs can range between 21% and 24% or higher. Paying high interest on quickly consumed items means a substantial portion of each payment goes towards interest, rather than reducing the principal. This increases the true cost of the experience, diverting funds that could be saved or invested.

Speculative Ventures

Borrowing money for highly uncertain or speculative ventures presents substantial financial risk, as the potential for significant loss is amplified. This includes using borrowed funds for activities like gambling, investing in unproven startups, or purchasing assets solely based on the hope of rapid appreciation. Unlike lower-risk investments, speculative ventures offer no guarantee of return. The core principle is that debt magnifies both gains and, more importantly, losses. If a speculative venture fails, the original “investment” may be lost, yet the borrower remains obligated to repay the full loan amount plus interest. This can result in a net loss far greater than the initial amount invested. For instance, if borrowed money is used to buy volatile stocks that then decline sharply, the investor loses the capital but must still service the debt. This can lead to severe financial distress, as the debt burden persists long after the speculative asset has become worthless.

Existing Debt

Using a new loan to pay off existing debt can be a precarious financial strategy if not approached with extreme discipline and a clear plan. While consolidating multiple debts into a single loan, often with a lower interest rate, appears beneficial, it primarily shifts the debt rather than resolving its underlying causes. For example, taking a personal loan to pay off high-interest credit card balances might reduce monthly payments or total interest. However, this strategy frequently fails if spending habits are not simultaneously addressed. Individuals might pay off credit cards with the new loan, only to then run up new balances, resulting in a higher overall debt load. While a debt consolidation loan can simplify payments and potentially improve credit utilization over time, it is not a solution for irresponsible spending. A successful consolidation requires a strict budget, a commitment to avoid new debt, and often the closure of old credit accounts to prevent recurrence. Without these behavioral changes, consolidating debt merely delays and potentially exacerbates financial difficulties.