8 possible risks of unsecured personal loans

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Life can cost you dearly, and sometimes you may need to borrow money to pay for certain items that your current cash levels simply won’t cover. This can include financing a large item, covering medical bills, consolidating debts, etc. At these times it makes sense to borrow money and there are plenty of loans to choose from when you need financing. The simplest is a personal loan, sometimes referred to as an unsecured loan.

You can use this indefinite loan for just about any purpose you want. You could pay off a high interest credit card, fund an adoption, or pay other expenses that you don’t have the funds for.

Before signing the agreement, however, you should consider the risks that come with some aspects of these loans. Here are the eight most common risks.

Key points to remember

  • Personal loans can help you pay for many types of large purchases, but they come with risks.
  • Interest rates are based on your credit score.
  • There can be a number of different fees attached to the loan.

1. The interest rate

Just because you qualify for a personal loan doesn’t mean you should take it. Some personal loans have interest rates well below 10%, while others can be three or four times higher. The interest rates on these loans depend on your credit score, but lenders can charge whatever they want, as long as the rate complies with certain laws.

Also be careful when comparing annual percentage rates (APRs). The APR can be manipulated. Instead, look at the total amount you will pay on the loan, including interest, fees, and principal, over the life of the loan. It is a better measure of the final cost of the loan.

2. Penalties for early payment

Are you allowed to prepay the loan or is there a penalty or fee for doing so? Depending on the type of personal loan you get – from a bank, through peer-to-peer loans, or other means – some lenders will be more favorable than others to your early repayment of the loan. If a prepayment is important to you (and it should be), read the fine print carefully to make sure no penalties are involved.

3. Significant upfront costs

How much will it cost you to get the loan money into your bank account? As with a mortgage loan, the initial loan origination fees can vary widely. You want to make sure that any upfront fees you pay are fair and up to market levels. There are many providers with varying terms, so don’t feel like you have to take the first loan you’re approved for.

4. Concerns about confidentiality

Loans from banks and credit unions will come with strict confidentiality rules, but other options may be considerably less formal. While all lenders must follow privacy laws similar to those required for banks, some cannot.

5. The insurance argument

Some personal loans come with a sales pitch for additional insurance to protect the loan in case “unforeseen life events” hamper your ability to repay. If you want insurance for this purpose, call an agent you trust and get a quote on general disability insurance. It’s probably cheaper and has better coverage.

6. Pre-calculated interest

Basically, the pre-calculated interest uses the original payment schedule to calculate your interest, regardless of how much you actually paid on the loan. Simple Interest looks at what you owe today and calculates your interest on that number. Be sure to ask the lender how the interest is calculated. If you’re hoping to prepay the loan, you want straightforward interest.

7. Payday loans

Payday loans are a form of short-term personal loans that finance gurus and government agencies advise consumers to avoid. The interest rates are very high and the terms often require people to renew the loan for additional terms.

8. Unnecessary complications

A loan is a simple product. Someone gives you money and you pay it back with interest. If a business offers you payment holidays, cash back offers, or other incentives, understand that the business is not going to lose any money on the transaction. The only possible loser is you. A personal loan should be easy to understand. If not, it’s a red flag.

The bottom line

Because most consumers are not qualified in the act of arbitration, loans are almost always stacked in favor of the lender and not the borrower. If you are looking for a loan for a want rather than a need, consider saving for the purchase. If you decide to take out a personal loan, make sure you know the risks involved. Plus, using a personal loan calculator to find the monthly payment, loan term, and interest rate you’re comfortable with can help you know exactly to ask.


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