Watch Out for the Risks of Personal Loans

Banks and fintech startups are increasingly offering personal loans for consumers who need to consolidate debt, make home repairs, or take care of other financial obligations. While personal loans are becoming easier to access, there still remains some risks to watch out for before you take on new debt.

Fixed Monthly Payments

There’s a fixed monthly payment based on your interest rate, loan amount, and repayment period. Payments can be difficult to make if you’re having financial trouble. Anytime you take on debt, you’re committing your future earnings to repaying that debt. It’s tough to look down the road and see what’s coming in your financial future. Be sure you have a solid emergency fund in place and don’t tie up too much of your income into repaying a loan. Otherwise, even a small unexpected expense can have a major impact on your finances.

Potentially High Interest

Your credit history may only allow you you qualify for a high interest rate. Personal loans are unsecured and interest rates are typically based on your credit score alone. If you don’t have a great credit score, you could end up with a higher interest rate and a higher monthly payment to go along with it.

Pay attention to whether you have a fixed or variable interest rate. A fixed interest rate will stay the same for the duration of the loan. A variable interest rate, on the other hand, may change based on the economy. Variable interest rates means variable monthly payment and difficultly budgeting for your loan payment.

Interest on the loan is calculated upfront, so you may not have a chance to reduce the total amount of interest you pay by paying your loan off sooner. In fact, some loans come with prepayment penalties so make sure you read the fine print before you accept the loan.

Impact for Future Loans

The loan raises your debt-to-income ratio, which comes into play if you’re trying to buy a house. Mortgage lenders look for a debt-to-income ratio below 40%. High personal loan payments combined with credit card and auto loan debt can make it difficult to qualify for a mortgage loan even if you have a good credit score. If you have a high debt-to-income ratio, you may have to pay off some of your balances before you can move forward in the home buying process.

Upfront Costs

There may be upfront fees before you can take on the loan. Depending on the lender you choose, there may be application and loan origination fees due before the loan is complete. Fees may be up to 6% and can be paid directly to the lender or taken from the loan. Be on guard for advance fee loan scams, which trick you into paying upfront for loans that don’t exist. Shop around and read reviews to be sure you’re choosing a reputable lender.

Consequences of Defaulting

Defaulting on a personal loan comes with stiff penalties. You’ll be charged late fees for the first several missed payments while it becomes increasingly difficult to get caught up again. Late payments and default will also hurt your credit score and your ability to get other loans in the future. While the lender may eventually write off a defaulted loan, you’re not off the hook. You may face a lawsuit and could have your wages garnished to repay a defaulted loan.

Personal loans are manageable when you borrow wisely. Make sure you’re not borrowing more than you can afford to pay and avoid loans with bad financing terms. If you’re having difficulty making payments, contact your lender as soon as possible to learn what option are available until you’re back on track again.