I read an article the other day that was somewhat of a surprise to me. The article was regarding consumer debt in America. It wasn’t surprising to see that the amount of student loan debt and debt to finance new cars have risen substantially over the last number of years. However, what was somewhat of a surprise was to read that personal loans are now the fastest growing type of consumer debt in the United States. According to the report, personal loans increased last year nearly 12 percent from the previous year. What was also somewhat surprising to me was that the average personal loan balance is now over $15,000, which is higher than the average credit card debt in America.

Personal loans are simply an unsecured debt. Unlike auto or home loans where there is an underlying asset that acts as security for the loan, there is no such security in a personal loan. In addition, it is important to know that the interest on your personal loan is not tax deductible.

I believe the surge in personal loans has to do not only with the fact that we are in an improved economy and people feel more confident about borrowing, but in addition, there has been an explosion of companies offering personal loans and they have been very aggressive in advertising. Also, obtaining a personal loan is much easier today than in the past. In the past, personal loans, particularly for people with bruised credit, were difficult; that is no longer the case today. In fact, with the internet, anyone can literally apply and be approved for a loan within minutes.

In many situations, personal loans are better than charge cards. Particularly, for someone with good credit in that they can obtain a personal loan at a much lower interest rate than on their charge card. On the other hand, for people who have bruised credit, the rates on personal loans can be substantially higher than charge card debt.

Whether or not personal loans are good for the consumer depends on how the money is being used. If someone is using a personal loan to refinance high interest rate charge card debt, a personal loan can be useful. On the other hand, someone with difficult credit may find that obtaining a personal loan is quick and easy, but could have devastating effects on their finances.

Whenever anyone borrows money, whether it is for a car, a house, or to finance an education, it is always important to think twice and make sure to have a game plan on how the loan will be repaid and an understanding of how the loan works. For example, unlike a charge card, with a personal loan you pay fixed installments over a set period of time until the loan is repaid.

For someone who is maxed out on their charge cards and getting a personal loan to pay them off, it can be a good move because it can dramatically reduce the interest you are charged. However, if you’re just going to max out your charge cards again, it’s not such a good move. The key is how you are going to use the proceeds from the loan. For example, if someone asked whether they should take out a personal loan to finance their gift-giving for the holidays? My answer would be absolutely not.

Like every other type of financial tool, a personal loan can make sense for you if you use it correctly. On the other hand, if you use it improperly, it can cause you severe financial distress.

One last note, if you are thinking about a personal loan, be sure to shop it around. Not only do you need to look at the interest rates, but all the costs. Costs do matter.

Good luck!

Rick is a fee-only financial advisor.  If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.