One Big Personal Loan Trap to Avoid in 2023

Don't fall victim to this blunder. If you do, you might regret your loan application.

When you need money, you'll often hear that a personal loan can be an affordable way to borrow. And you'll very often be privy to a lower interest rate on a personal loan than you will on a credit card.

But if you apply for a personal loan in 2023, there's a big trap you might fall into. And this holds true regardless of what your credit score looks like.

Don't be shocked by higher rates

Inflation has been a problem for consumers for well over a year. And it's forced many people to rack up debt and raid their savings just to do basic things like pay rent and put food on the table.

The Federal Reserve, meanwhile, has been on a mission to slow the pace of inflation. To achieve that, it's been implementing interest rate hikes since early 2022.

Last year, the Fed raised interest rates seven times. And it's already raised rates twice this year for a total of nine hikes since March 2022.

The Fed does not set consumer borrowing rates directly. The rate you'll pay to take out a personal loan, for example, will be determined by the lender you apply with. Rather, the Fed oversees the federal funds rate, which is the rate that banks charge one another for short-term borrowing purposes.

But when the Fed raises its federal funds rate, it tends to indirectly drive up the cost of borrowing on a whole. And so if you apply for a personal loan this year, you may find that the rate you're offered is higher than what you'd like it to be. And unfortunately, this might hold true even if your credit score is excellent.

Personal loans are unsecured, so generally, the higher your credit score, the more likely you are to snag a competitive interest rate on one. But even if your credit score is an 820 out of 850 (which is unquestionably excellent), you might find that the personal loan rate you're presented with is anything but affordable. That's just a symptom of today's borrowing environment.

It could pay to put off your personal loan application

If your need to borrow money isn't particularly urgent, then you may want to hold off on applying for a personal loan until borrowing rates come down on a whole. That could mean waiting until 2024 or even beyond. But doing so might save you a lot of money on interest.

If you are going to take out a personal loan this year, take your time shopping around for one. You may find that although rates are generally up, there's one lender whose offer is far more competitive than the others you're presented with.

At the same time, if your credit score needs work, aim to boost it before moving forward with a personal loan application. Raising your credit score by 40 or 50 points could make a big difference in the interest rate you qualify for -- and that could, in turn, result in much lower and more affordable monthly loan payments.