If you’re looking to finance a large purchase, a personal loan may be a good option for you. Interest rates on these loans are typically lower than those of credit cards, but there are still some risks to consider and potential personal loan mistakes you could make.
If you’re considering taking out a personal loan, it’s important to think about your motivations. What do you hope to achieve by taking out this loan? Clarifying your goals can help you make the best decision for your financial future and avoid these personal loan mistakes.
Before applying for a loan, it’s important to know your credit score and have a budget in place for repayment. It’s also beneficial to do your research and compare the best offers from different lenders in order to get the most favorable terms. By taking these steps, you’ll be in a good position to find a lender that meets your needs.
1. Taking out a loan with longer terms than necessary
Out of the personal loan mistakes you could make, the first one is accepting a long repayment term. The longer you take to repay your loan, the lower your monthly payments will be. However, this also means that the lender will have more time to collect interest from you, making the overall loan more expensive. Additionally, personal loans with extended payment periods often come with higher interest rates.
Let’s imagine you take out a loan for $10,000 at 7 percent interest and repay it over 36 months. Your monthly payments would be $308.77 and you would pay a total of $1,115.75 in interest. However, if you extend the loan term to 60 months, your monthly payments will drop to $198.01 but you will end up paying $1,880.72 in interest over the life of the loan.
If you’re looking to take out a personal loan, it’s important to choose one with a shorter repayment term. This will help you avoid paying too much interest. If you’re worried about being able to afford the monthly payments, use a loan calculator to determine an amount that works for your budget. You may have to borrow less, but it’ll be better for your finances in the long run.
Summary: A shorter loan term means you pay less interest to the lender, resulting in savings. Longer loan terms result in lower payments, but more interest paid over the life of the loan.
2. Not shopping around to find the best offers
When you need money urgently, it can be tempting to go with the first lender who approves you for a loan. However, this could also be one of the costliest personal loan mistakes. There is no way to know whether you are getting the best deal or whether there are better options available.
Take, for example, a $15,000 loan. If your bank offers you a 48-month loan at 9 percent interest, your monthly payments will be $373.28 and you’ll pay $2,917.23 in interest over the life of the loan. However, your local credit union may offer the same loan amount and term with a 5 percent interest rate.
There are plenty of benefits to shopping around for loans when you’re tight on time. For one, you can explore different loan options from banks, credit unions, and online lenders without affecting your credit score. Additionally, using a loan matching tool can help you see potential offers in minutes. Some lenders also allow you to get pre-qualified online and view loan offers with no credit check. So if you’re in a bind and need a loan fast, remember that it pays to shop around.
Summary: If you’re looking to compare rates from different lenders, getting preapproved can be a quick and easy way to do so without harming your credit.
3. Not paying attention to your credit score
Among the most common personal loan mistakes is not considering your credit score. Most people think that in order to get a loan, you need to have a good income and employment history. However, there is another factor that is just as important: your creditworthiness or the likelihood of you paying back the loan on time.
Credit scores are one of many factors that lenders consider when approving a loan. A low credit score may result in a higher interest rate and could mean paying hundreds or even thousands of dollars more in interest. In some cases, a lender may deny an application outright.
If you’re thinking of taking out a personal loan, it’s a good idea to check your credit score first. This will give you an idea of where you stand and whether you’re likely to be approved for a loan. If your credit score is on the lower end, there are other options available to get the cash you need. In the meantime, review your credit report and file disputes if you notice inaccurate or outdated information that could be dragging your credit score down.
Summary: Different lenders have different minimum credit score requirements. If your score falls below a lender’s cutoff, it may be better to wait and focus on improving your score before applying for a loan.
4. Ignoring potential fees and penalties
Loans can come with a variety of fees that can be costly if not taken into account, such as:
- Application fees: These are the fees charged by lenders to prospective borrowers when they apply for a loan.
- Late payment fees: If you’re ever running behind on a payment, be aware that most companies will charge you a fee for making a payment after the due date.
- Origination fees: Processing fees, also known as origination fees, are charges assessed by the lender to establish the loan. These fees can range from 1 percent to 8 percent of the loan amount and are generally paid at closing.
- Prepayment penalties: If you pay your loan off early, your lender may charge you a prepayment penalty.
- Returned check fees: Bounced check fees are the charges you’ll incur if your payment is rejected by your bank.
There are ways to avoid paying fees on your loan, like making timely payments. You can also look for lenders who don’t charge application or origination fees. If you plan to pay your loan off early, look for lenders who don’t have prepayment penalties.
Summary: When researching lenders, be sure to consider all fees that may be charged in addition to the interest rate. Some lenders do not charge any fees, but most will have an origination fee and late fee.
5. Not reading the fine print
The loan process will not be finalized until you have agreed to the terms and conditions and signed the required documents. The lender may send these to you electronically or in person, and you will need to review them carefully. One of the worst personal loan mistakes is not reading the fine print. Only after you have signed off on everything will the loan proceeds be released to you.
The loan closing process can vary from lender to lender, but typically involves reviewing and signing several pages of documents. These documents usually contain important information about things like the interest rate, acceptable payment methods, due dates, and fees. It’s important to read the fine print carefully before agreeing to anything. Some lenders may charge extra for certain types of payments or automatically withdraw funds from your bank account on a specific day each month.
When you sign a contract without reading it, you could be in for an unpleasant surprise. The lender might withdraw your first loan payment and overdraw your account, which would result in fees from both the bank and the lender. Or, you might mail the first payment to the lender a week before it’s due, only to have the amount automatically deducted and the check cashed, leaving you with insufficient funds in your account. These are just a few of the many potential problems that could arise when you don’t read the fine print.
Summary: Be sure to review the fine print of any document before signing it. Ignoring the small print can result in unforeseen penalties or automatic payments from your lender without your knowledge.
Personal loan mistakes — The bottom line
Making the decision to take out a loan is a big one. Don’t rush into it without doing your research first. This could lead to you falling into these personal loan mistakes and paying more than you need to or getting rejected by lenders. One way to research a lending company is by looking at its file on the Better Business Bureau (BBB) website and reading its customer reviews.
Additionally, when you are looking for a loan, it is important to find one with a competitive interest rate. You also want to make sure that the monthly payments are affordable so that you can pay off the loan on time and avoid any costly consequences in the future. Shopping around and comparing different loans can help you find the best option for your needs.