Think Twice About Taking Out a Personal Loan

“The instant gratification can be a rush, but when you realize you have saddled yourself with paying off the loan month after month for years, that event or item loses some of its shimmer.”

Personal loans are more popular than ever. You get a flyer in the mail. You go online, and you get a decision almost instantly. That cruise or home improvement project can become a reality. Not so fast. These companies might advertise low interest rates, but the actual offer you receive might be as high as a credit card or higher. Many personal loans charge hefty “origination” fees. Before clicking that “Submit Application” button, you should get more information and think twice about taking out a personal loan.

If you are barely scraping by now, how will you make the payments for anywhere from two to six years on the personal loan? The instant gratification can be a rush, but when you realize you have saddled yourself with paying off the loan month after month for years, that event or item loses some of its shimmer.

When It Can Make Sense to Take out a Personal Loan

Let’s say you have credit card debt with a 28 percent interest rate. If you can get a personal loan for six percent, you can pay off those credit cards immediately and pay far less in total to pay off the personal loan than you would have paid by the time you zero balanced the credit cards paying those companies directly.

Your credit score will likely take a hit for a few months, until the credit cards post the payoffs. This is because it will look as if you suddenly doubled the amount of your debt. No worries, all other things being equal, your score will climb back to where it was before.

Alternatives to a Personal Loan

Depending on how much money you need, it could make better sense to use a 0 percent interest credit card offer to buy the item you want. The danger in this strategy is the 0 percent interest rate is temporary, so you need to pay off the debt before the standard credit card interest rate begins.

Things You Should Know Before Getting a Personal Loan

Americans do not save money like they used to. Around four out of ten people do not have the financial resources to pay for an unanticipated $400 expense. Since many people do not save money even for emergencies, they do not have the money to pay for large one-time purchases. It is so easy to go into debt, that many people think they do not need to have savings. The personal loan industry is making a fortune off that mentality.

During the last year, the personal loan market grew by 17 percent. In that same period, mortgages grew by only 3 percent, credit card debt by about 2.5 percent, car loans by less than 4 percent and student loans by a little over 5 percent.

Although only 3.6 percent of the mortgages taken out in 2018 were by subprime borrowers, these debtors took out more than 35 percent of the personal loans. If your credit score is under 630, you will likely pay more than 27 percent interest on average for a personal loan. Some personal loan borrowers pay as much as 36 percent interest. The default rate on personal loans is also double that of mortgages and nearly twice as high as for credit cards.

The lenders often charge fees, like origination fees, which they tack on to the total loan. This tactic seems like a painless way to get a loan, because there is no down-payment required. However, the fee, which can be $1,000 on a $20,000 loan, sits there and generates more interest you owe because it increases the total debt.

Make sure that you know the precise amount of interest and fees the lender will charge, before you commit to the loan. Get firm offers from several lenders, before you select one.

References:

HuffPost “Personal Loans Are Much Riskier Than Banks Lead You To Believe.” (accessed December 12, 2019) https://www.huffpost.com/entry/personal-loans-instant-gratification-risk_l_5d8a984ae4b01c02ca6054dc