A vacation loan might fuel an urgent trip (embark with caution)

Travel is expensive, but sometimes it’s necessary even if it costs more than you have on hand. A vacation loan could help make an urgent trip possible.

A personal loan is a tool you can use to cover expenses that are important to you. While it’s not always a good idea to borrow for a vacation, there are some times when a vacation loan might be the option that makes the most sense.

What is a vacation loan?

A vacation loan is a personal loan that's used to pay for a vacation or other travel. Usually, personal loans are unsecured loans. That means you’ll qualify based on your own credit standing and not whether you own something valuable that you can borrow against. 

How does a vacation loan work?

With a vacation loan, like other personal loans, you get all the money up front in one lump sum. Then you repay the amount you borrowed, plus interest. For many borrowers, the interest rate on a personal loan is lower than the interest rate on their credit cards, which makes a personal loan the less costly option. The rate is fixed, which means it won’t change for the life of the loan. The monthly payment on a vacation loan is the same every month, and you’ll have a set end date when your loan will be paid off. 

Vacation loan vs credit card vs buy-now-pay-later

Credit card

• What it is: A way to make purchases, pay them down, and make more purchases, up to your credit limit, as long as your account is in good standing.

• Interest rate: Often higher than personal loans. The rate is usually variable, which means it can go up or down along with market conditions. 

• Repayment: You only need to make the minimum payment each month, which makes it easy to drag the debt out for a long time. The longer you take to repay a debt, the more you’ll pay in interest. 

• When it’s a better option: Use a credit card when you can afford to pay off the bill completely. If you need time to pay, a credit card might be a good option if you can get a very low interest rate compared to other borrowing options.

• Risks to consider: Credit cards have very low minimum payments that are designed to repay the debt over a very, very long time. The longer it takes to repay the debt, the more it’ll cost you in interest overall. Also, credit cards make it easy to continuously charge more and stay in debt even longer. 

Vacation loan

• What it is: A personal loan used to pay for a vacation. You receive the money in one lump sum after your loan is approved, and you can't borrow more without applying for a new loan.

• Interest rate: Often lower than credit cards. The rate is usually fixed, which means it won’t change for the life of the loan. Your payment amount won’t change either, and you’ll have a set payoff date. 

• Repayment: Usually 2–5 years.

• When it’s a better option: When you don’t want to use a credit card, when your credit card limit isn’t high enough to cover the trip, or when the travel is urgent and you can’t put off the expense. 

• Risks to consider: You might be paying for several years for an event that might only last several days. Borrowing for a luxury item like a vacation might indicate that you’re spending above your means.

Buy-now-pay-later loan

• What it is: A very short-term loan that allows you to make a purchase now and pay for it over time (but usually not very much time).

• Interest rate: 0% to 36% 

• Repayment: For 0% interest loans, 2-8 weeks. For loans with interest, 1-4 years.

• When it’s a better option: When it’s free and you can afford to make biweekly payments to pay off your balance in under two months.

• Risks to consider: Some people who can’t afford to make the purchase today won’t be able to next month either. BNPL makes it easy to spend money, but often with unrealistic repayment requirements. Then, if you can’t afford to repay your BNPL loans, you could get hit with late fees, damage your credit, or fall behind on other financial obligations.

How much can you borrow?

Most personal loans are for $5,000 to $50,000 but you can find loans that are smaller or bigger. That may be too big for a vacation loan alone, but if combined with another purpose, such as a bathroom remodel, part of the loan could help pay for a vacation. 

How long do you have to pay off a personal loan?

Most personal loans are usually paid off in 2 to 5 years, and you can pick the term that works for your budget. A longer term means a lower payment, which can be helpful for affordability, but will have higher interest costs overall.

What are the fees for a vacation loan?

Most lenders charge a fee for making the loan. This fee, called a lender fee or an origination fee, is typically taken out of the loan amount. Origination fees typically range from 1% to 6%. A 5% origination fee on a $5,000 loan is $250, which is subtracted from your loan. 

Some lenders charge a prepayment penalty. That’s a fee for paying off the loan ahead of schedule. This is important to know because vacation loans are better if you pay them off quickly.. So if you know you can pay the loan off within a year, you should make sure there’s no penalty for doing so. 

Missing a payment or not paying your loan in full by the end of the term can result in late fees of $25 to $50, or between 3% and 5% of the monthly payment amount.

How do you qualify for a vacation loan?

Every lender sets its own requirements, but you’ll likely need to have a fair or good credit score, a steady income, and a debt-to-income (DTI) ratio under the lender’s limit. Your DTI is your monthly housing expense and debts divided by your monthly before-tax income. Lenders want to make sure you can afford the loan payment.

For example, if you bring home $5,000 a month and you have a $400 car loan, a credit card with a $200 minimum payment, and a $1,000 mortgage payment, your DTI is 32%. Your total housing and debt payments total $1,600. You’re using 32% of your income to make your required payments. If your DTI is under 36% you’re very likely to pass a lender’s affordability test. But don’t worry if it isn’t. Many lenders allow higher DTIs.

Is a vacation loan ever a good idea?

Here are some examples of when a vacation loan might be right for you: 

• You qualify for a low rate. Having good or excellent credit may qualify you for a low interest rate, which can make the debt more affordable when compared to a credit card.

• Emergency travel is required. A sick or injured family member, or a funeral, may require you to travel a long distance on short notice, before you have a chance to save up the money you need.

When you might want to avoid borrowing for a vacation

A vacation loan isn’t right for everyone. Here are some reasons you might want to avoid borrowing for a vacation:

• You have other debts. This suggests that you might be spending above your means, at least for right now.

• A new loan can make future, unexpected, expenses more difficult to pay for.

• Vacation loan fees may force you to borrow more than your vacation will cost.

• Adding another debt to your credit report could make it harder to get a loan you need in the future, such as for an emergency like a leaky roof.

4 tips for covering your vacation

Here are four other ways to pay for a vacation:

1. Vacation savings account. Create a separate savings account for travel and add to it regularly.

2. Credit card rewards. If you have credit card points, you might get some travel expenses covered. However, if you don’t pay your credit card balance off each month, then you'll inevitably end up paying more in interest than what you’ll reap in free travel perks. But if you already have the points, then use them.

3. Pick cheaper destinations. Instead of a trip to Rome in the peak summer season, visit cheaper cities in Italy such as Florence and Naples during the off-season. Or pick areas closer to home, and stay in budget hotels or a vacation rental where you can prepare your own meals.

4. 0% intro credit card. If you can qualify and you can afford to pay off the debt in a short amount of time, consider applying for a 0% promotional interest rate credit card and put your vacation expenses on the card.