3 Problems With Personal Loans All Borrowers Should Know About

During the third quarter of 2023, U.S. personal loan balances rose to $241 billion, reports TransUnion. That's up almost 15% from the third quarter of 2022.

All told, more than 5 million borrowers put a personal loan in place during 2023's third quarter. So clearly, these loans are pretty popular among consumers.

You may have heard that personal loans are a great way to borrow money when that need arises. And in some cases, they can be a good solution. But here are a few problems you should be aware of.

1. They're really flexible

When you sign a mortgage loan, you can only use the proceeds to finance the purchase of a home. When you sign an auto loan, you can only use that money to buy a car.

Personal loans aren't like that. With a personal loan, you can use your proceeds for anything -- home improvements, travel, or starting a business.

That flexibility is nice -- but only to a point. Because personal loan lenders don't tend to care what you're using your money for, it can be tempting to sign one of these loans for the wrong reason, like to upgrade your home's electronics or spruce up your wardrobe. 

In reality, taking on debt is a big deal. And there can be serious consequences to falling behind on personal loan payments. So if you're going to put one of these loans in place, do it for something important, like creating extra living space within your home or covering the cost of classes to further your career. Don't do it to buy items you'd like to have but don't really need.

2. Rates can be less than competitive when your credit is poor

Personal loans are unsecured, which means you're not putting up a specific asset as collateral. The lenders that write these loans take on a lot of risk, and they rely heavily on credit scores to determine which applicants get approved or not.

It's possible to get a personal loan with poor credit. But if that's your situation, you may be looking at a borrowing rate that's not so competitive to make up for the added risk your lender thinks it's taking on. That could make your loan less affordable than expected.

3. The fees associated with them can be high

When you put a personal loan into place, there can be various fees, like origination fees, that add to your costs. This isn't unique to personal loans -- other loan types charge fees, too. But it's important to read the fine print when signing a personal loan and know exactly what fees you'll be on the hook for.

Some lenders will allow you to roll your fees into your actual loan and pay them off over time. That might seem like a good thing. But it might also cause you to be more lax with those fees, which you don't want to be. Instead, make sure you know exactly what you're being charged -- and shop around if you think those numbers are ridiculously high.

In some cases, it can make a lot of sense to turn to a personal loan when you need to borrow money. But before you sign one, make sure you understand the potential pitfalls involved.