A loan may seem like your ticket to a dream vacation when you lack the cash to cover the hefty price tag upfront. A vacation loan is simply another name for a personal loan you use for travel.
But looks can be deceiving.
That vacation loan you use to finance your seven-day Caribbean cruise could leave you shackled to debt for years and affect your ability to obtain credit when you need it.
Before you take out a travel loan, read the fine print. What appears to be a good deal may not be once you look closer at fees and interest rates.
[Read: Best Personal Loans.]
How do vacation loans work?
The idea of buying now and paying later could be an appealing alternative to no vacation. Just 42% of Americans said they were confident that they would take a summer vacation in 2019, according to a poll conducted on behalf of travel insurance provider Allianz Global Assistance. More than half cited financial concerns as the chief reason they weren’t taking vacations.
Enter vacation loans. A vacation loan is typically unsecured, which means you use your credit history and income instead of collateral to secure the loan.
You repay your vacation loan in equal monthly installments for a fixed term. Repayment terms generally range from two to seven years, but some lenders may offer shorter or longer terms.
The interest rates for vacation loans tend to be lower than those of credit cards. You will pay an average rate of 10.63% on a 24-month personal loan, compared with 17.14% for a credit card, according to the Federal Reserve.
Still, the exact terms of your loan will depend on your credit. If you have less-than-perfect credit, some personal loans could charge you an annual percentage rate upward of 30%.
And you could end up going into debt to pay for a luxury.
Downsides of taking out a travel loan?
Whether it’s the pressure from social media or the feeling that you deserve a break, justifying a loan for your dream vacation is easy. But doing so may end up causing more problems than it solves.
“The reality is if you really can’t afford it, and it’s not in your budget, it’s not something you should be purchasing,” said Leslie Tayne, debt resolution attorney, best-selling author and founder of Tayne Law Group.
Yes, travel loans may be better than credit cards and other options to cover travel costs. But think twice before you take one. Some of the downsides of a vacation loan:
It can add unnecessary stress. A 2018 U.S. Travel Association survey says 82% of Americans travel to relax and reduce stress. But taking on debt, such as a travel loan, to fund a vacation can add stress in the long run.
“Traditionally, when someone uses a vacation loan, it’s an indication that they’re not saving and budgeting properly,” said Kent Fisher, a certified financial planner at Southern Investment Management Collective.
And if you already have a hard time saving, then paying monthly for travel over several years could make it that much harder. Even if you can afford your payments, the loan will make managing financial risks down the road more difficult.
Tayne asked, “What happens when something comes up that’s an emergency or a requirement for money, and now you have this responsibility to pay back this loan for a vacation that you took?”
[Read: Best Bad Credit Loans.]
It can be expensive. Even if you qualify for a good interest rate on a personal loan, interest charges can add hundreds — or even thousands — of dollars to the cost of your vacation.
Let’s look at an example using a $5,000 loan repaid over two years. If your credit is good, you might have an APR of 10.63% and pay $572 in interest on your vacation. If your credit isn’t in great shape and your interest rate is 35%, the cost jumps to $2,022.
A longer loan term may reduce your monthly payment, but you will pay more in interest.
Vacation loans may also include origination fees, which can add to the cost of your trip. Not every lender charges an origination fee, but when a lender does, the fee figures into your loan’s APR.
Fees typically range from 1% to 6% of your loan amount and often come out of your loan proceeds. If you take out a $5,000 loan with a 5% origination fee, you would receive $4,750.
Once you factor in fees, your estimated loan amount could be off the mark. You may need to borrow more for a trip than you had planned.
“Most people don’t really stick to budgets when they go on vacation,” Tayne says. “There’s a lot of justification for overspending on vacation, and that generally creates more debt.”
It can limit your borrowing options in the future. Virtually every time you borrow money, that debt is added to your credit report, and lenders can view it when deciding whether to extend you credit.
“A person can only borrow so much money,” Fisher says. “If you’ve used up some of your loan capacity to take on a personal loan to go on vacation, you’re limiting your options on what you can do.”
Mortgage lenders, for instance, may limit how much you can borrow if your debt-to-income ratio — your total monthly debt payments divided by your gross monthly income — exceeds 43%.
Even if you’re not planning to buy a home or borrow money for other reasons in the near future, a lot can happen in a few years. If your car breaks down and you need a new one, or your views on homeownership change, you may regret your vacation loan.
When might vacation loans be worth it?
Ideally, you will budget for your travel and pay for it with cash you’ve saved. But in a pinch, a loan can finance your trip when you do not have other options, such as credit card rewards or room in your regular budget.
You might need a vacation loan for:
Emergency travel. If a loved one is sick or injured, or has died, you may need to use a travel loan to get to family. If your travel plans are urgent, make sure to search for personal loans from lenders that can provide quick cash.
Once-in-a-lifetime trips. Special circumstances may justify vacation loans, Fisher said, although avoiding them is still best.
As long as someone is financially disciplined, he said, “I can see a case being made for a young person making a once-in-a-lifetime trip … and saying, ‘I know that I’m dipping into future reserves to consume today.'”
[Read: Best Mortgage Lenders.]
What are vacation loan alternatives?
If you are long overdue for a getaway, you may lack the patience to wait until you can afford to pay for it with your savings. But other options afford the same experience, if not better, without the drawbacks of vacation loans. Alternatives include:
Savings. The best way to pay for a vacation is sometimes the old-fashioned way. Saving for a once-in-a-lifetime trip can take time, though. If you’re hoping for a vacation sooner than later, perhaps set your sights on a more affordable trip.
Look at your income and expenses, and find ways to redirect certain expenses toward your savings. If you can’t do this, consider ways to earn a little extra cash to set aside just for travel.
Credit card rewards. Travel credit cards allow you to travel for less and, in some cases, nearly for free. By signing up for one or more credit cards and earning their sign-up bonuses, you could use points and airline miles to cover flights, hotel stays, rental cars and more.
If you want to go this route, though, you must have a plan to use credit cards responsibly. That includes sticking to a budget to avoid spending more than you earn in rewards and paying your bill on time and in full every month to avoid interest charges.
If you have saved some but not all the money you need for a trip, you could shop for deals that could make your dream vacation a reality. Many travel websites offer deals on flights, hotels, cruises and more, but you often need to be flexible with your travel dates and even destinations.
Thinking creatively can also help you score a great experience for less. “You can go online and get a million different suggestions on how to have the best staycation or vacations on a budget,” Tayne says. “When my college-age kids go on vacation, they don’t have big budgets, and they find really interesting ways to go on vacation and save money.”
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