Personal loans can be an important resource when you require significant cash for an immediate need. Generally, they have no restrictions on use and lower interest rates than credit cards. They’re often used to consolidate debt or manage an immediate and unforeseen debt like medical expenses. But before you sign on the dotted line, make sure you understand the risks involved. Taking out a personal loan for something you want and don’t absolutely need is rarely advised. Unfortunately, there’s no shortage of offers available, even for people with poor credit. Read on to find out how to avoid common pitfalls associated with personal loans.
Don’t overborrow
This may sound simple, but when someone offers you $7,500 when you only needed $5,000, you may think it’s a great idea to take as much as they’ll give you. This philosophy couldn’t be further from the truth. Borrowing extra money extends the length of the loan and the amount of interest you pay.
Taking out a personal loan for a vacation, expensive wedding or recreational equipment like a jet ski may seem like an easy path to instant gratification. Instead, start saving for these things by setting up an account just for that purpose. Don’t put yourself into more debt to keep up with friends or family members. Borrow only what you need and only when you really need it.
Unable to make payments
Finding yourself unable to make one or more monthly payments is probably the biggest risk to consider before taking a personal loan. But if you’ve done your homework, this shouldn’t happen, right? Not necessarily. Even if you’ve run the numbers, unforeseen health issues or job loss can change things. If you default on a loan, your credit future is in jeopardy. The lender may bring legal action which could result in having your wages garnished or a lien put on the property you own. An emergency savings fund is important to have and can help cover payments when something unexpected occurs.
Does it save you money?
Many people take out a personal loan to refinance or consolidate debt. While this may make it easier by managing just one payment, will it also save you money? Interest rates are based on your credit and may be fixed or variable. Do you know if your rates will change? Longer-term loans may cost you less per month, but you’ll be paying it back for longer, thus adding additional interest. There’s also more to consider than the interest rate. Look at the total amount you will pay to borrow the money. This includes the principal, interest and other fees you could incur. Read the fine print to know if there are origination fees or fees for late-payments or early payoff. These can affect the overall cost of the loan.
Conclusion
Paying off a personal loan on time can help your credit score, but don’t let borrowing become a habit. Borrowing money to consolidate credit card debt just to start charging again defeats the purpose. If you default on a personal loan, you could face difficulty when you need to borrow in the future. Finally, when you do decide a personal loan is the right choice, shop around for the best rates and terms.