3 Personal Loan Traps to Avoid Right Now

Your best bet is to steer clear of these.

When you need to borrow money, there are different options you can look at. You can always charge up a balance on your credit cards and pay it off over time, but doing so might cost you a lot of money in interest. You can also borrow against the equity you have in your home. But if you're a renter, that's not an option for you.

That's why many consumers find themselves turning to personal loans when a need to borrow money arises. A personal loan lets you borrow for any purpose. It can be to take a vacation, fix up your car, or renovate your house. And the upside of taking out a personal loan is that you might snag a more competitive interest rate than what a credit card will charge you.

But while personal loans may be convenient, flexible, and relatively affordable, it's important to be careful when taking one out. Here are some traps you'll want to avoid if you want to borrow via a personal loan.

1. Getting stuck with a high interest rate

While a personal loan might cost you less in interest than another borrowing product, you'll be paying interest nonetheless. And right now, you might get stuck with a higher personal loan rate than you'd like due to today's borrowing environment.

The Federal Reserve has been on a mission to cool inflation, and to do so, it's been implementing aggressive interest rate hikes. That's made it more expensive to borrow money in different ways. But it also means that if you apply for a personal loan this month, or in the near future, you might get stuck with an interest rate you aren't happy with.

2. Taking on loan payments when a recession might hit

For months, financial experts have been cautioning consumers to gear up for an economic recession in 2023. Now we can't say with certainty that economic conditions are going to decline in the new year. But it is a possibility.

If you take out a personal loan now, and then you lose your job in 2023 during a recession, you might struggle to keep up with your monthly payments. That could cause extensive damage to your credit score, making it very difficult to borrow the next time you need to.

3. Applying for a loan when your credit score just dropped

Personal loans are unsecured, which means they aren't tied to a specific asset (whereas if you take out a mortgage and fall behind on your payments, your lender can eventually force the sale of your home to get repaid). That's why it's important to have a strong credit score when applying for a personal loan. The higher that number, the lower your interest rate is likely to be.

But a lot of people have fallen behind on bills this year due to inflation and the struggle to keep up with higher living costs. If that's happened to you, and your credit score has dropped, then applying for a personal loan could mean getting stuck paying a lot of interest -- and having a hard time keeping up with your monthly payments.

A personal loan could end up being a smart borrowing choice for you at some point in time -- maybe even today. But do be aware of these potential traps and the ways they can hurt you financially.