Inflation has hit Americans hard, whether it’s the price of a carton of eggs or the cost of utility bills. And while the rate of inflation has slowed slightly in the last few months, Federal Reserve Chairman Jerome Powell told Congress on March 7, “Although inflation has been moderating in recent months, the process of getting inflation down to 2% has a long way to go and is likely to be bumpy.”
It’s easy to see why someone might seek to borrow to deal with unexpected costs – but what does this mean for long-term debt? Is it really a good idea to take out another loan as interest rates rise? Experts say probably not.
Personal Loan Debt Rising Alongside Interest Rates
In an effort to manage escalating costs, many Americans have turned to credit cards and personal loans. According to TransUnion’s 2022 third-quarter report, the average credit card debt and average personal loan debt per borrower rose $617 and $1,362, respectively, between 2021 and 2022.
“The increase in personal loan applications is likely due to the availability of online applications and the ease with which borrowers can access these loans,” says Derek Miser, investment advisor and CEO at Miser Wealth Partners in Knoxville, Tennessee.
“Personal loans may provide quick access to cash, but they are often not the best strategy for debt management, as they often come with high interest rates and fees.”
Unfortunately, interest rates are rising alongside the increase in loan debt.
“Borrowers may be tempted to take out more than they can afford, leading to a cycle of debt and a worsening of their financial situation,” Miser says.
TransUnion data supports this fear: The borrower-level delinquency rate for personal loans is up 1.37 percentage points year over year.
Are Personal Loans a Good Way to Manage Unexpected Costs?
There are many good reasons to take out a personal loan, from consolidating credit card debt to financing a home improvement. But the key factors in deciding whether a personal loan is a good idea are whether you can qualify for a good interest rate and can consistently make payments toward your debt.
“Personal loans are not always a good idea in a rising interest rate environment, because of the cycle it perpetuates,” says Gary Grewal, a certified financial planner and director of advisor relations at Pattern Technologies. “The full accrued interest cannot be paid off each month, so the balance continues to grow.”
Consider whether a personal loan is to help you get out of a truly tight spot, or if it’s to manage everyday purchases, which means you may not be able to afford payments.
Pros of Taking Personal Loans to Manage Large Purchases
“Loans can be the right solution in certain situations if the borrower has a plan for managing the loan payments,” says Miser.
As long as you have a reliable income and a manageable repayment plan, it can work for you. Plus, personal loans typically offer a fixed interest rate, so if you are carrying a lot of debt with a variable rate – such as a credit card – it might actually be the better option as rates rise.
“A debt consolidation loan could still be a good option if you’re able to qualify for a significantly lower rate than you’re currently paying on your credit accounts – and if you have a secure job,” says Anna Serio-Ali, personal lending expert and former editor at Finder, a personal finance comparison site.
Still, Serio-Ali warns borrowers to take a close look at their budget before taking any loan.
“Anyone who applies for a personal loan should make sure there’s still room in their budget after covering the new monthly payments,” she says. “Inflation is still on the rise, and unless your company gives you a raise that matches the inflation rate, you’ll likely have a tighter budget a year from now.”
Cons of Taking Personal Loans on Long-Term Debt
Though there are certain situations where taking out a personal loan to combat inflation makes sense, most experts agree it is a risky strategy.
For one, borrowing a loan for everyday purchases can lead to a dangerous cycle of debt.
“Taking out personal loans to support yourself during inflation is not a good long-term strategy, because the interest rates on these loans are often much higher than those on other types of loans, such as mortgages or auto loans,” Miser says. “Additionally, the principal amount of these loans is usually not enough to cover rising living costs, so the borrower may end up taking out additional loans to make ends meet.”
Also, the money you allocated toward loan payments might not stretch as far as it used to as inflation continues. Then you won’t be able to add it to your budget without defaulting.
“Inflation-era prices can make it difficult to pay back loans, as the money you borrowed may no longer be worth as much as when you first borrowed it,” Miser says. “This can lead to increased interest payments and a longer loan repayment period.”
Serio-Ali adds that having an emergency fund is more important than ever during inflation. If you get laid off, loan payments can strain a limited budget, she says.
Plus, with rates higher than in recent years, it’s just not the best time to take on large projects that can wait. They’ll be more expensive.
“Lenders also tend to react to rising interest rates by tightening the requirements to qualify for low rates and fees,” Serio-Ali says. “This means that you may not be able to save much by consolidating your debt with a personal loan – if you can qualify at all.”
Alternatives to a Personal Loan for Debt Management
“The best way to get out of debt is to avoid it in the first place, so if inflation is putting pressure on your budget, look at the biggest chunks of your budget – housing, gas, utilities, food – and see if there are areas you can temporarily cut back on, or seek out assistance,” Grewal says. “Many cities and counties have subsidized internet and stipend assistance with utilities.”
Before turning to a personal loan, it’s important to consider whether the purchases you want to cover are going to be a part of your budget for the foreseeable future. If the answer is yes, you likely need a long-term budgeting solution for managing these costs. If you can’t find any costs to cut, you could consider taking on a side hustle to bring in extra money.
If you are facing a one-time or short-term cost you need to cover, personal loans are not the only option.
“While personal loans can be an attractive alternative to credit cards and other high-interest debt,” Grewal says, “there might be better options if you really need a loan, such as a 401(k) loan, life insurance loan or home equity loan.”
Should You Consider Taking Out a Personal Loan to Manage Inflation Costs?
Personal loans can be a more affordable option than credit card debt, but they’re not a good long-term solution for purchases that will continue to be in your budget.
Before taking out a personal loan, make sure you have a solid repayment strategy and have considered how rising interest rates will affect your budget in the months or years it will take to pay it off.