A personal loan is money lent by a bank, credit union, or third-party lender for all purchases, such as consolidating debt, refinancing, or making a big purchase.
One thing to avoid is taking on a loan with a high-interest rate, as this can significantly increase the total cost of the loan.
They typically come with lower interest rates than credit cards, making them a popular financial tool.
When considering a personal loan, it is important to avoid certain pitfalls that can lead to financial difficulties. One thing to avoid is taking on a loan with a high interest rate, as this can significantly increase the total cost of the loan. It is also important to avoid taking on a loan that is too large for your budget, as this can lead to difficulties in making timely payments and potentially damage your credit score. It is always a good idea to shop around and compare offers from multiple lenders to ensure you get the best deal and the most favorable terms.
But First: How Do Personal Loans Work?
A personal loan is money lent by a bank, credit union, or third-party lender for all purchases, such as consolidating debt, refinancing, or making a big purchase. They typically come with lower interest rates than credit cards, making them a popular financial tool. However, like other forms of credit, personal loans should be taken out responsibly.
Here are a few common personal loan terms you’ll see that will help you better understand the application process and which we’ll mention throughout this article:
- APR: Annual Percentage Rate, or APR, is one of the most important terms to understand. There are often fees associated with taking out a personal loan, such as an origination fee or application fee. The APR has all of the fees plus the interest baked in so you can see the real cost of the loan. Always look at the APR when comparing lenders.
- Principal: This is the amount you’re borrowing. So if you apply for a personal loan of $5,000, that number would be considered the principal. As you pay off the loan, this amount will gradually decrease, but the APR charge will stay the same (assuming it’s a fixed and not variable rate).
- Interest: The interest is essentially what the lender charges to lend you the money you’ll repay over the life of the loan. Every month, you’ll pay back a piece of the loan amount (the principal) plus the monthly interest, which is typically a percentage rate.
- Monthly Payment: The monthly payment made to the lender will include a portion of the principal you owe as well as the interest which you’ll be obligated to pay over the course of the loan.
- Origination Fees: This is an upfront fee some lenders will charge you when processing your loan application and can sometimes be referred to as points. Not all lenders charge an origination fee, but if they do, it will be calculated into your APR.
Now let’s move on to some of the most common personal loan mistakes you can avoid this season!
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1. Not Checking Your Credit Report
Before you start sending in personal loan applications, check your credit report. You’re entitled to one free credit report each year from the three major bureaus—TransUnion, Experian, and Equifax.
If you’re curious about what your financial profile looks like, this is your credit report. It’s a breakdown of all of your credit history and is crucial when it comes time to apply for loans of all types since it’s something lenders will examine to determine your creditworthiness.
Here is what you can expect to find on your credit report:
- Your name
- Current and previous addresses
- Date of birth
- Social Security number
- Phone number
- All current and previous credit accounts and account types, such as loans, mortgages, etc.
- The credit amount and limit
- Account balances and payment history
- Opening and closing date of accounts
- The name of the lender/creditor
Public Records and Inquiries
- Civil suits
- Companies that have looked at your credit report
As you can see, your credit report provides incredibly detailed insight into your financial standing, past, and present, so you must be aware of what’s on it. Most lenders will explicitly state on either their website or over the phone which is and isn’t eligible to take out a loan with them. For example, some third-party lenders won’t offer personal loans to anyone with a recent bankruptcy or foreclosure. Knowing this will help save you time and manage your expectations.
It’s also a good idea to look at your credit report just in case of an error. If you find a mistake, dispute it immediately to remove it from your report.
2. Only Paying Attention to the Monthly Payments
When taking out a loan, it’s normal to narrow our focus on the monthly payments since that’s a financial burden taken on for months, maybe even years, until the loan is paid off. You want to make sure it’s an amount you’re comfortable paying. While monthly payments are important when considering various lenders, they shouldn’t have the final say in your decision.
As mentioned earlier, a few other costs are associated with taking out a personal loan, such as interest rates, application fees, and origination fees. A common tactic many lenders—even the most reputable—will employ to earn your business is to offer a lower monthly payment as a way of veiling these fees. Additionally, a lower monthly payment may mean a longer loan term, which will cost you more in interest in the long run.
In general, a loan will come with these extra fees, but not all. Some companies offer their services without any application fees.
3. Not Comparing Lenders
We get it, you need money and want to secure a personal loan fast. Slow your roll! Remember, there are a ton of loan providers out there—not just your traditional banks or credit unions. Put in some time to research and compare lenders, including third-party online providers, to find the best rates rather than jumping at the first one.
If you’re pressed for time and don’t want to go through filling out entire personal loan applications with every lender, you’ll find that many online loan providers will allow you to submit a quick preliminary application—which usually takes just a couple of minutes to fill out—to see what kind of rates you’re pre-approved for. Additionally, there are online loan marketplaces, such as Monevo, which are free to use and allow you to submit just one form with a soft credit check that won’t harm your score, and receive offers from multiple lenders—making it even easier to make quick comparisons.
When comparing lenders, the most important things to look at are the APR, monthly payment, and loan term.
4. Choosing Loan Terms that Don’t Match Your Goals
No two financial profiles are the same, and we each may have varying reasons and goals when taking out a personal loan. For instance, you might be taking out a personal loan to pay off medical bills or fund a large vacation, and your primary goal is to secure a loan with a lower monthly payment and a longer repayment term. If your goal, however, is to get out of debt faster, having this longer repayment term won’t help.
Cost is another thing to consider when opting for a longer repayment term since you’ll be paying more interest over the life of the loan. For example, if you’ve decided to take out a loan for $5,000, know that you’ll be paying that principal amount plus interest and fees. While your interest rate is the same no matter the loan term, selecting a longer loan term will ultimately cost you more in the long run.
Again, it all comes down to what your goals are, so be sure to understand the terms when taking out a personal loan.
5. Missing or Making Late Payments
Aside from putting money in your pocket, a personal loan has other benefits, such as helping to build your credit. Don’t negate this perk by missing payments or making late payments. Doing so will harm your credit score and overall creditworthiness, making it harder to secure another loan in the future.
Additionally, if you’ve taken out a secured loan, missing or making late payments will run you the risk of losing the collateral attached to the loan. This is why it’s important to evaluate all aspects of taking out a personal loan, including ensuring that you can afford the monthly payments.
Remember that you’re obligated to these monthly payments for the duration of the loan, and being late or missing just one payment could hurt your financial standing.
The key when taking out a personal loan is to do so responsibly and to take your time. Rushing through the process could mean less desirable loan terms and not hitting your financial goals.
A personal loan is a powerful financial tool when used smartly, so do your research, find the best lender for you, and be prepared so you can avoid these common personal loan mistakes this season.