Here's Why So Many Consumers Are Taking a Risk With Personal Loans

There's a reason personal loans have long been a popular borrowing choice among consumers. Not only do these loans tend to offer relatively competitive interest rates, especially compared to credit cards, but they're extremely flexible.

When you sign a mortgage, you can only use your loan proceeds to finance a home purchase. The same applies to an auto loan -- it must be used to pay for a vehicle. With a personal loan, you can borrow money for any purpose, whether it's to fix up your home or start a business.

But recent data from TransUnion reveals that personal loan balances have grown a lot over the past year. And that means consumers are taking on even more debt at a time when interest rates are higher.

Personal loan balances are climbing

During the first quarter of 2022, U.S. personal loan balances totaled $178 billion. During the first quarter of 2023, they reached $225 billion. That's a year-over-year increase of 26.3%. By contrast, U.S. credit card debt rose just 19.2% during that same time period -- "just" being a relative term, of course.

Now to be clear, it's generally more optimal to borrow money via a personal loan than a credit card. Not only do personal loans tend to come with lower borrowing rates, but also, they offer the benefit of fixed interest rates. With a credit card, the interest rate on your debt can climb over time, making your balance more difficult to pay off.

The problem, however, is that personal loan balances are increasing at a time when borrowing is more expensive across the board. The Federal Reserve has been trying to cool inflation by implementing interest rate hikes. In fact, the central bank raised interest rates during 10 consecutive meetings beginning in March 2022 before finally pausing that practice this past June.

The Fed doesn't set consumer borrowing rates directly. But its interest rate hikes have been driving the cost of consumer borrowing upward. So the fact that consumers are taking on more personal loan debt isn't so comforting. Higher interest rates are apt to be making that debt more expensive, which means it's more of a burden for borrowers and there's more of a risk of borrowers falling behind.

Be careful when taking out a personal loan

You may be eager to take out a personal loan despite borrowing costs being up. But waiting a bit of time to sign a loan could mean snagging a lower interest rate. So if your need to borrow money isn't all that pressing, you may want to sit tight and hold off.

You should also be aware that many financial experts are still sounding near-term recession warnings in light of the Fed's string of rate hikes. That, too, is a good reason to wait to borrow money.

If economic conditions worsen, it could lead to an increase in unemployment. And the last thing you'd want in that situation is a monthly personal loan payment hanging over your head.