Many people turn to personal loans when they need a fresh injection of cash. Such loans can be used to fund a home repair, or to pay off credit card debt. But it is easy to fall behind on personal loan payments. And if that happens, you might end up in a tough spot, says Michael Bovee, founder of Consumer Recovery Network, an organization that helps people manage their debt.
“There are not a lot of options to get lower payments on personal loans,” Bovee says.
Major banks and credit card issuers often work with nonprofit agencies to lower interest rates and monthly payments when borrowers run into trouble, Bovee says.
By contrast, most companies offering personal loans are not so willing to bargain.
“If you are unable to pay on these loans, you may quickly find yourself evaluating bankruptcy, or working out settlement agreements with collection agencies after your accounts have been in default a few months,” Bovee says.
The danger of missing personal loan payments
The danger for borrowers is real. About 1.9% of all personal loans were at least 30 days delinquent during the third quarter of 2017, according to the American Bankers Association.
That was a sizable jump from the 1.52% delinquency rate in the third quarter.
Personal loans are a type of unsecured loan. That means they are not secured by collateral, such as a home or car. Because an unsecured loan is riskier for the lender, you typically will pay higher rates on personal loans than on other types of loans.
Those higher rates — and the higher payments that come with them — can easily get you into financial trouble.
So, if you plan to take out a personal loan, know what you are getting into first. And make sure you are borrowing responsibly, and for the right reasons.
For example, Bovee says he talks to many people who get into trouble after taking out a personal loan to pay off credit cards and other bills.
Once these borrowers use the loan to pay off the debt, they soon find themselves returning to those credit cards — and spending to the point that they are deep in debt again.
Thus, the monthly payment on the personal loan — which was once affordable — “can quickly become a struggle if credit card debt becomes problematic again,” Bovee says.
So, don’t take out a personal loan to pay down debts unless you have a long-term plan to quit spending more than you earn.
“Do not play musical chairs with unsecured debt,” Bovee says.
How to avoid trouble with personal loans
Falling behind on personal loan payments can have severe consequences. Your lender might turn to a collection agency to get you to pay up. Or, the lender could take you to court, putting you at risk of having your wages garnished.
The best way to avoid trouble paying off a personal loan is to make sure you have the budget to afford your payments each month. Fully understand your financial situation before you sign up for a personal loan.
“Be sure your personal finances can handle the loan payments, and any temporary shock to your income,” Bovee says.
If you are using the loan proceeds to pay off other debts, like credit cards, close some of those accounts once the balances are zero.
“Perhaps keep only one or two of your oldest established credit cards open,” Bovee says.
That way, you can keep your credit options open — and your credit score higher — without falling prey to the lure of racking up more debt.