5 Ways a Personal Loan Can Go Very Wrong

Making a personal loan work for you involves planning and management.

Personal loans can be a great way to consolidate your debt or pay for a big home improvement project, but there are a few things to watch out for when you take out a personal loan. 

1. Missing out on a better deal

It's easy to believe that one lender is as good as another, but nothing could be further from the truth. Lenders compete for your business, and it's up to you to find the lender offering the best deal. 

If you're worried that loan shopping will negatively affect your credit score, there's no reason. Credit reporting agencies like TransUnion, Equifax, and Experian expect consumers to shop around for the best loans. If you get your loan shopping done within a relatively short period (two weeks, to be on the safe side), it shows up on your credit report as a single inquiry. For example, if you apply for a personal loan with seven different lenders during that time, your credit report will show that you applied with one lender. 

The point is this: Whether you have a very high credit score or a not-so-great credit score, the interest rate and terms offered by various lenders differ. If you automatically accept the first lender's offer, you could spend thousands of dollars more than you would have with another lender. 

2. Borrowing more than necessary

When you take out a loan, it's tempting to fall into the trap of borrowing as much as the lender tells you you're qualified to borrow. Let's say your bathroom was last remodeled during the Truman administration, and it's seriously past time for an upgrade. You plan to borrow $25,000 but are told you can easily qualify for $40,000. Suddenly, you think of how you could use the additional money. 

One of the fastest ways to make a positive loan experience turn bad is to borrow more than you need. For example, if you were to borrow $25,000 for four years at 9% interest, your monthly payment would be $622 per month, and you would pay a total of $4,862 in interest. Accepting the extra $15,000 means your monthly payment would be $1,120, and you would pay $8,752 in interest. 

Bottom line: Borrowing more than you needed to accomplish your original goal would cost an extra $3,890. That's nearly $4,000 you could have invested for the future or put away for a rainy day. 

3. Failing to read the fine print

It's in the fine print that you'll discover the details that can impact your life. For example, you'll want to know if there's a prepayment penalty, how much you're paying in origination fees and other tacked-on costs, and if credit insurance is available.

Once you've decided to take out a personal loan, it's easy to ignore the fine print to get to the good stuff -- funding the loan. But if you don't want to regret the loan once the funds are in your bank account, read the fine print first.

4. Failing to create a budget that works

Before the pandemic hit American shores in 2020, 3 out of 10 adults had no monthly budget. Now, that number is closer to 2 out of 10. Unless your monthly budget is accurate, taking out a new loan can be dangerous. 

Let's say your loan has a monthly payment of $500. At first glance, your income should be more than enough to cover expenses. However, if you fail to factor in a month with unusually high utility bills, trips to the emergency room, or a broken down car, it could be tough to pay the loan when it's due. 

It's impossible to plan for every eventuality in life or anticipate all the tiny things that go awry, but building a budget that works means factoring in unexpected expenses. That way, you can always make your loan payment, even when surprise bills pop up. 

5. Sliding back into trouble

One of the best uses for a personal loan is debt consolidation. If you're carrying high-interest debt, landing a personal loan with a lower APR can save thousands of dollars. However, if you use a debt consolidation loan to pay off your existing debt, then go out and buy a new car or max out your credit cards, you'll be in worse shape than before you consolidated.

Personal loans can be a great financial tool for accomplishing your goal -- as long as you remain in control from the time you apply to the day the loan is paid in full.