Don’t Fall for these 3 Personal Loan Traps

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Understand the three most common personal loan scams to use this type of debt without it using you.

Hey frugal friends! Today’s post is from Joseph Hogue of Peer Finance 101 (and other great personal finance sites.) It’s on the touchy subject of personal loans. I like his perspective on it and I hope you will too.

-Jen

In 2009, I couldn’t get a loan to buy a pack of gum. That’s how bad my credit was after the housing bubble burst.

I got caught squarely in the worst financial crisis in a century. I ended up losing most of my savings, investments and the rental houses that caused the whole mess.

I still had some debts, most of which had reset to sky-high interest rates when I started missing payments. There was no way I was ever going to pay them off at those rates. I was barely able to make payments as it was.

The sorry thing was, I had always been good about debt. I rarely used my credit cards and always tried to pay them off at the end of the month. I paid cash for my car, a used (but new-to-me) Saturn. Other than the mortgages on my rental properties, I hadn’t strayed much from my debt-free journey.

If I could just get the money to pay off the loans and not be trapped by the interest payments.

A bank loan was out of the question. I couldn’t even get a loan on the equity in my home. My car wasn’t worth enough to borrow on and I didn’t have anything left to sell.

That’s when I first started thinking about personal loans.

What I found was a legitimate source of debt but one that was rife with scams and interest-rate traps. Getting a personal loan can be the best worst option but you’ll need to avoid some of the common mistakes borrowers make.

I would rather you use other types of debt, cheaper loan options, but if you are going to use personal loans then a little information will go a long way in helping you get the best deal.

What are Personal Loans?

 

Rather than put up collateral like your house or car for a loan, personal loans are unsecured. All you need is a credit score and a signature.

While traditional banks offer personal loans, the internet is making an ever-bigger chunk of this lending. Over the last decade, lending sites have popped up for every type of loan and purpose. That makes personal loans even easier to get but also more difficult to regulate by authorities.

Personal loans usually come with higher rates compared to loans secured by your home or other assets but less than payday lending or cash advances. Sometimes good credit borrowers can even get personal loans at rates below their credit cards, which makes debt consolidation a favorite for borrowers.

Most personal loans are made on three- or five-year terms and on fixed rates. You’ll know exactly what your monthly payment is going to be before you accept the loan.

Why Would Anyone Consider a Personal Loan?

 

I don’t want you to get the impression that personal loans are dangerous or something you should avoid altogether. These loans are definitely on the high side of rates but there are instances where a personal loan makes sense.

• If you can get a personal loan at a rate below that which you’re paying on other debt then a debt consolidation loan can save you money. Debt consolidation wraps up all your high-interest debt and puts you on a payment plan to pay it off. 
• Personal loans can save you from being forced into the payday loan trap. Like any pusher, payday lenders only give you enough to get you over your short-term needs. They know you’ll be right back borrowing and paying their fees in a couple of weeks. You’ll be able to borrow enough on a personal loan to get you out of that debt cycle and get back on your feet.

Each of these instances has a ‘but’ that you need to know about. Debt consolidation is a great tool BUT don’t use it as a way to free up space on your credit cards to go shopping. Personal loans can be a longer-term solution compared to cash advances BUT you still need to ask yourself why you are in such a deep financial crisis and how you can avoid it in the future.

Avoiding Personal Loan Traps and Scams

 

Now that you know a little about personal loans and why you might need them, I want to help you avoid the biggest loan scams and traps out there. Like any financial product, there are people out there using it to take advantage of people in need.

1) Always remember to shop around for your personal loan rates. High-interest rates on a personal loan don’t necessarily mean it’s a scam but they can certainly trap you into debt.

Almost all personal loan platforms run what’s called a soft-inquiry on your credit to estimate your rate. This doesn’t affect your credit score so there’s no harm in checking your rate on several platforms.

Saving just 4% on a $10,000 personal loan will mean saving over $700 in interest over 36 months.

2) Never accept a personal loan offered in an email that was sent to you without signing up on their website. The biggest scams are these mass email rip-offs. Scammers send out hundreds of thousands of emails offering low rates and fast money. They’ll ask you for bank account information, credit card numbers and other financial information.

By the time you realize you’re not getting the money, your accounts have been cleaned out.

All lenders, online or otherwise, must be registered to do business in every state where they provide loans. It takes less than five minutes to check on your state attorney general’s website or to call up the state regulator. Besides making sure the lender is licensed, you’ll also be able to see any complaints filed against them.

3) Loans with no credit check may not be a scam but you don’t want them either way. Anyone promising to lend you money without a credit check is either just going to rip you off or the interest rate will be so high they might as well have ripped you off.

Lending is a very competitive business. Rates are determined by complex calculations of how much the lender needs to charge based on a person’s credit history and how likely they are to pay the money back.

If someone is offering to lend money with no idea about your credit history, that means they’re going to charge you so much upfront and over the life of the loan that half their borrowers could default and they’d still make mountains of money.

Don’t be afraid of your credit score. It takes years to build a score and days to ruin it. We’ve all been there and there’s nothing wrong with a bad FICO. According to the people that calculate your credit score, one-in-five Americans has a credit score below 600 on the FICO scale.

Personal loans shouldn’t be your first choice for a loan or money needs but they can be a useful tool in certain scenarios. You can use these loans for any purpose and rates are fixed so your payment will never change. Just make sure you watch for the most common scams and traps so you are using the debt wisely and it’s not the scammers that are using you.

 

Joseph Hogue worked as an equity analyst and an economist before realizing being rich is no substitute for being happy. He now runs five websites in the personal finance and crowdfunding niche, makes more money than he ever did at a 9-to-5 job and loves building his work from home business.