Is Taking Out That Personal Loan a Big Mistake?

Taking out a personal loan is often -- but not always -- a good idea. Watch out for these red flags when deciding if borrowing makes sense for you.

Taking out a personal loan is often -- but not always -- a good idea. Watch out for these red flags when deciding if borrowing makes sense for you. 

Personal loans are often a good form of financing. They are unsecured, so you aren't putting assets at risk as collateral, and the interest rate tends to be lower than a credit card. Personal loans are also flexible because you can use the money you borrow for anything you want, including consolidating other debt.

But just because personal loans can be helpful, that doesn't mean it's always a good idea to take one out. In fact, in some circumstances, getting a personal loan could be a big mistake. This could be the case for you if any of the following things are true. 

1. You can't afford the monthly payments

When you take out a personal loan, your monthly payments are determined based on the amount borrowed, the loan term, and your interest rate. If there is even a small chance you won't be able to afford the monthly payments for a loan you're considering, you absolutely shouldn't borrow.

Taking on a debt you aren't sure you can pay off is a recipe for disaster. If you pay late or don't pay at all, you could end up damaging your credit and incurring late payment fees. If you fail to pay back your loan, you could also find yourself in court if the lender sues to collect -- and this lawsuit could lead to wage garnishment or other dire consequences. 

Be sure you understand up front how much your personal loan payment will be, whether it might change, and how it will fit into your budget. If you have too little income and don't think you can pay the bill on time each month, walk away from the loan.

2. You're borrowing for a non-essential purpose

There is never a reason to borrow money for things you want but don't really need. If you borrow, you'll have to pay interest, which makes the purchase more expensive in the long run. The debt payments will also make it more difficult to live within your means.

While lenders market personal loans as the perfect way to pay for vacations, home upgrades, weddings, and big purchases, you should avoid taking on debt for any of these things. Instead, wait until you've saved up the cash to cover the costs and don't commit to years of payments for something that won't improve your financial situation over the long term.

3. You're borrowing to pay off debt but don't have your spending under control

Debt consolidation is a popular reason for taking out a personal loan and it can be a good one. If you owe a lot of high interest debt and you can take out a loan at a lower rate to pay it off, this may seem like a no-brainer. 

Unfortunately, if you borrow to repay your debt but don't have your spending under control, you risk ending up in a worse financial position. If you use the personal loan to pay off your credit cards but then end up charging them up again, you'll have both the loan and credit card bills to pay.

To make sure this doesn't happen, create a budget and live on it for a little bit. That way you'll know you won't reach for the credit cards you've just paid off with borrowed funds from a personal loan.

4. You're borrowing from a lender offering bad terms

While personal loans generally have reasonable interest rates that are lower than credit cards, this isn't always the case. Some loans that cater to bad credit borrowers can be very expensive. And some lenders market loans as personal loans when they're essentially just payday loans by another name. 

Make sure you know the interest rate, fees, repayment timeline, and monthly payment before you agree to any personal loan. If the rate is high, or you’ll be stuck paying the loan for a very long time, or there are exorbitant fees, it’s better not to borrow. 

Don't end up making a big mistake when it comes to taking out a personal loan

If you can't find a loan at a reasonable rate, if you're borrowing for something you don't really need, or if there's a chance you can't afford the monthly payments, you should absolutely not take out a personal loan. Doing so would be a major mistake that could ruin your credit, cost you a fortune, and undermine your financial security for a long time to come.