There are many reasons to take out a personal loan, like financing a big purchase or even paying off debt, but you’ll want to consider several factors before you do. Here are seven personal loan mistakes to watch out for — and how you can avoid them.
7 Personal Loan Mistakes to Avoid
1. Not Shopping Around for the Best Deal
There are a ton of personal loan options out there and no reason to choose the first one you find. Since so many lenders offer the chance to apply for a pre-qualification, which only requires a soft credit pull, you can find out what you might qualify for on several loans without lowering your credit scores.
Therefore, you can go ahead and collect a few pre-qualified offers to see which lender has the best deal for you. As for what the best deal entails, you might want to consider things like the interest rate, the payoff time frame, and the fees. The less you pay in interest and fees, the better — but it’s still important to make sure you can easily afford the monthly payments.
2. Not Calculating the Fees
Personal loans can come with a variety of fees. Some fees to be aware of include origination fees, late payment fees and prepayment penalties.
Origination fees are the fees you pay for taking out the loan, and are typically a percentage of the balance. Prepayment penalties are fees some lenders charge for paying off a loan early. Consider all the fees that come with the loans you pre-qualified for when you decide on the best offer for you.
3. Taking On a Higher Interest Rate
It’s fairly common for people to take out a personal loan to pay off high-interest credit card debt, but there’s no guarantee that a personal loan will have a lower interest rate than a credit card.
What’s more, you might find that a variable rate loan comes with a lower initial interest rate, but that doesn’t mean you’ll have that lower interest rate forever. Keep the entire range of possible interest rates in mind if you’re considering a variable rate loan compared to a fixed-rate loan.
4. Not Understanding Variable Rates
Speaking of variable rates, it’s important to understand what they can do to your monthly payment. If the lowest end of the range of possible interest rates create a payment that’s already at the top end of your budget, then you might have real difficulty staying current on your payments if that rate goes up.
Variable rate loans are not a problem in themselves, but it’s important to make sure you’ll be able to afford your monthly payments should your rate increase.
5. Choosing Terms That Don’t Match Your Goals
Since there are many reasons someone might want to take on a personal loan, there are many factors to consider in choosing that loan. You might, for example, be excited to see a loan that gives you a lower monthly payment amount when you choose a longer repayment term. That could be great if your goal is to have a low monthly payment. But if your goal is to get out of debt faster, then a longer repayment term can work against you.
Cost is also a factor when considering the repayment time frame. Let’s say you’ve decided to finance something that costs $10,000. You’re already going to pay more than the original amount for whatever you financed ($10,000 plus interest and fees), but selecting a longer repayment term means that you would pay more than you would with a shorter repayment term, if both options have the same interest rate.
6. Falling for a Scam
It’s easier than ever these days to get a personal loan thanks to the prevalence of loans that can be obtained online. However, the convenience also comes with an increased risk of falling for a scam.
You can help protect your credit and your identity by keeping an eye out for red flags such as “guaranteed credit approval.” You can find even more warning signs in this list from the Federal Trade Commission.
7. Missing a Payment or Paying Late
Finally, once you choose a personal loan, it’s important to stay on top of your payments. Missing a payment or paying late could damage your credit and cost you in fees. What’s more, if you’ve taken on a secured loan, missing payments could mean losing the collateral tied to the loan.
This goes back to the importance of making sure the loan you choose comes with payments you can afford — and not just today. Consider what your financial obligations will be for the entire duration of the loan and select an option that fits comfortably in your budget.
Take Your Time Before Deciding On a Personal Loan
Personal loans can be useful tools, both for financing purchases and paying off debt. However, if you have a little bit of time before you need the loan, it might not be a bad idea to use that time wisely by working on your savings so you can take out a smaller loan. You can also work on your credit so you can obtain an affordable interest rate. The better prepared you are, the better your experience with personal loans can be.