3 Problems With Taking Out a Personal Loan You Should Know About

Be mindful of these before you submit your application.

Personal loans have long been a popular borrowing option among consumers. And as of the fourth quarter of 2022, U.S. personal loan balances amounted to a whopping $222 billion, according to TransUnion.

You may be thinking of applying for a personal loan today if you need money. But before you do, be mindful of these pitfalls.

1. They can almost be a little too flexible

When you take out a mortgage, you can only use your proceeds from that loan to buy a home. And when you sign an auto loan, you can only use that money to finance a vehicle purchase.

Personal loans let you borrow money for anything you want. You can take the money and use it to renovate your home, buy furniture, go on vacation, or purchase 600 T-shirts with your favorite catchphrase on them. 

Yes, the latter probably isn't a very good idea. The point, however, is that the option exists. And that's not necessarily a great thing.

It's nice to have flexibility as a borrower, but that might lead you to borrow money for a non-essential reason. And that means you'll be racking up interest charges when you probably shouldn't be.

2. Falling behind on your payments could lead to serious credit score damage

Any time you fall behind on a loan payment, your credit score could take a major dive. Personal loans are no exception. 

Even though personal loans are unsecured, which means they're not tied to a specific asset as collateral, you're still required to keep up with your payments on schedule. If you don't, and you're reported as delinquent to the credit bureaus, your credit score might plunge, making it extremely difficult to borrow the next time you need to.

3. You might get stuck with a higher interest rate due to today's borrowing environment

The Federal Reserve has been raising interest rates in an effort to slow the pace of inflation. The Fed doesn't set consumer borrowing rates directly, which means it technically has no say as to what personal loan lenders charge. 

But when the Fed raises its benchmark interest rate, which it did seven times in 2022 and once already in 2023, that tends to drive up the cost of consumer borrowing on a whole. Right now, you might get stuck with a higher interest rate on a personal loan than you'd like. This holds true even if you're a borrower with solid credit.

Granted, if you take out a personal loan, you might snag a lower interest rate than you would with, say, a credit card. But that doesn't mean you won't get stuck overpaying due to factors you're completely not in control of.

Borrowing money with a personal loan may be an option worth exploring this year. But before you sign that loan agreement, keep these potential issues in mind -- and see if it's worth pursuing another borrowing option, like a home equity loan, or holding off on taking out a loan altogether.