Should You Consider a Holiday Loan?

·7 min read

You might think a holiday loan can take away the stress of expenses at the most wonderful time of the year, but a loan can backfire. If you're not careful, you can overstretch your budget and end up even more stressed about how you will pay the bill.

Americans planned to spend about $1,000 on holiday-related purchases in 2020 for themselves and their families, according to a National Retail Federation survey. These expenses may seem like necessities, but they're not if you have to borrow more than you can afford to repay.

If you haven't been able to save money for holiday shopping and are thinking of taking out a loan, here are some important considerations and alternatives.

[Read: Best Personal Loans.]

What Is a Holiday Loan?

A holiday loan is a personal loan used for holiday expenses , from plane tickets to gifts , and issued by financial institutions such as banks, credit unions and online lenders.

Holiday loans are typically unsecured, which means they don't require collateral, and they are available in low dollar amounts of $500 to $5,000. The size of your loan and your interest rate can depend on factors such as your credit score and your income.

Although a holiday loan offers predictable payments and spreads them out over time, it is still considered bad debt. Bad debt doesn't provide a return on your investment and can make your financial situation worse, according to the credit bureau Equifax.

"Credit card debt or personal loans for things like holiday gifts are really bad debt," says Robert Johnson, professor of finance at Creighton University's Heider College of Business. "They tend to come with much higher interest rates and crowd out your ability to save."

How Do Holiday Loans Work?

The terms of holiday loans vary considerably, but borrowers can expect to make fixed payments over 12 to 60 months. Most lenders require a good credit score to qualify for a holiday loan, especially one with a lower annual percentage rate than what you're paying on your credit cards.

You will lock in your APR and know your monthly payment when you take out the loan. Here is an example of terms for holiday loans from Baltimore-based Securityplus Federal Credit Union.

The lender offers amounts between $1,000 and $7,500 at APRs from 6.99% to 9.49% and repayment terms from 12 to 48 months. If you borrowed $1,000, qualified for an APR of 6.99% and selected a 12-month term, you would pay $86.52 monthly.

Note that some lenders charge origination fees, usually 1% to 6% of the loan amount that may be added to your balance or deducted from what you receive. Also, if you need quick cash, you may be able to get your money the same business day as approval.

[Read: Best Home Equity Loans.]

Other Ways to Finance Holiday Expenses

Personal lines of credit. A personal line of credit may be secured or unsecured and functions like a credit card but has a fixed duration of up to 15 years. Credit lines range from $300 to $100,000 with APRs of 8.25% to 17.74%, which may be lower than your credit cards, according to the credit bureau Experian.

Credit cards. Plastic can be an expensive way to cover holiday costs if you can't pay off your balance when it is due. If you need to spread out payments over a few months, you will likely pay more interest using a credit card than a personal loan if you have good credit.

Personal loans. Personal loans that aren't marketed as holiday loans may also be an option.

Credit card loans. This is money you borrow against your card limit and then pay back in installments over a repayment term that varies from six months to five years. The loan is deposited directly into your bank account within a couple of days after approval, and the payment is tacked onto the minimum due each month. APRs are fixed and usually lower than purchase or cash advance rates.

Peer-to-peer loans. With a peer-to-peer loan, a lending site handles the loan administration, but the money comes from individual investors or institutions that choose to fund your loan. Depending on your credit, peer-to-peer loan terms may be comparable to a personal loan or personal line of credit.

Pros and Cons of Holiday Loans

Pros:

-- Qualify without collateral.

-- Get fast cash for holiday expenses, sometimes as soon as the same business day.

-- Use the money with few restrictions.

-- Pay lower APRs than with credit cards, if you have good credit.

-- Break up holiday expenses into fixed monthly payments.

Cons:

-- You will pay interest on holiday expenses.

-- You could pay fees on top of principal and interest charges.

-- You may not find a lender with minimums small enough to meet your needs.

-- You will increase your debt load unless you plan to pay off the loan immediately after the holidays.

-- You may not qualify for a loan, or you may qualify with a high APR.

-- You could overextend your budget and end up making payments long after the holiday season.

If you get a holiday loan every year, you may find that catching up is tough, says Brandon Renfro, owner of financial planning firm Belonging Wealth Management.

"By the time you roll around to the next holiday, you're probably still feeling the effects from the previous one," Renfro says.

Holiday Loan Alternatives

Instead of a loan to fund a happy holiday, consider:

-- Setting a budget for holiday expenses. Look at your cash flow and your savings to help you establish a reasonable spending limit.

-- Saving throughout the year. Build a holiday fund if you can, Johnson says. "Create a specific savings account for holidays, and put $25 to $50 a week into the fund," he says. "It's a dedicated fund, and you know those dollars are your holiday spending dollars."

-- Buying a little at a time. Start early to get the gifts and the deals you want and to spread out your purchases, reducing the effect of holiday shopping on your wallet.

-- Cashing in credit card rewards. If you have a rewards credit card, check your rewards balance. You might have points, miles or cash back rewards you can redeem to help with holiday expenses.

-- Scaling back on holiday spending. You can achieve this goal by sticking with a list, setting expectations with friends and family members, and searching for promotions and coupons.

-- Earning extra holiday cash. Consider a seasonal job, side gig or freelance work that can add to your income.

-- Using a buy now, pay later service. You might think about this option, a type of modern layaway, if you have bad credit and want to pay for a large purchase in installments. No minimum credit score is required to use services such as Affirm, Afterpay and Klarna, and some plans may charge interest and late fees.

[Read: Best Debt Consolidation Loans.]

When to Get a Holiday Loan

A holiday loan could make sense if you know that you can pay off the balance quickly. As long as you can wipe out your debt within one to two months, it may be a good choice, Johnson says.

Maybe you are expecting a windfall, such as a year-end bonus you will use to pay the loan as soon the money arrives. In that case, a holiday loan could come in handy.

"But if you don't have the prospect to pay back that loan very quickly, have a less commercial Christmas," Johnson says.

If you are considering a holiday loan, make sure you shop around and compare:

-- Interest rates. Holiday loans should have better APRs than your credit cards if you have good credit.

-- Repayment terms. Many loans have 12-month terms, but longer terms will mean paying more in interest.

-- Fees. Watch out for origination fees and prepayment penalties that take away from a good interest rate.

-- Prequalification. Does the lender allow you to prequalify, which allows you to shop around without hurting your credit score? Once you find a lender that offers terms you like, then you can submit a full application and agree to a hard credit check.

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