Take a fine-toothed comb to your loan offer before accepting. You want to make sure you understand everything in the contract; otherwise, you may have to be forced to pay surprise fees in the future. These are the most important aspects of the personal loan to evaluate:
- APR: What is the interest rate? Is it fixed or variable? Is the rate lower than the one on your credit card? If not, then taking out a loan may not be worth it.
- Repayment period: How long will you be making monthly payments, and at what point will the loan need to be paid off?
- Monthly payments: Can you afford the payments? Do they fit into your budget?
- Secured or unsecured: Will you need to put up your bank account, for example, as collateral for the loan? Or does it not require collateral?
- Origination fee: Do you have to pay a fee up front for the loan, and if so, what does it cost? Is the lender being transparent? Keep in mind that many lenders that don’t require this fee still charge it anyway. It’s just reflected in your interest rate.
- Prepayment penalty: Will you be penalized with a charge if you want to pay off the loan early?
Do: Get pre-qualified by multiple lenders
Pre-qualification is a process where you self-report your financial information and desired loan terms to get an informal estimate of what personal loan you’d be qualified for. This step is different from getting a pre-approval or actually applying for the loan, because it doesn’t require the lender to review and verify your documents and it won’ result in a hard credit inquiry that would decrease your credit score by a few points. And pre-qualification doesn’t mean you’re actually approved; it just tells you whether you’re likely to be approved and what your loan terms might be.
Getting pre-qualified is a quick, often instantaneous process that allows you to see what loan amount, interest rate, and terms you would receive. You can get pre-qualified by an unlimited number of lenders. We recommend getting estimates from at least three lenders so you can understand what is available to you, based on your credit profile.
Personal Loan Don’ts
Always shop around before committing to a loan. It’s not just the obvious banks that are offering personal loans now. You can also find them at credit unions, community banks, online banks, and online lenders, many of whom could offer you a better rate than your garden-variety mega-bank.
All lenders evaluate applications differently, with variables like income and credit weighted differently depending on the criteria. So you may find one bank doesn’t like that you were laid off from a job, while another doesn’t care because you have an “excellent” credit history. It all depends on factors outside your control, so make sure to expand your options.
Don’t: Take out the maximum loan possible
We don’t recommend taking out a big loan just because you can afford it. A loan payment that seemed manageable upon approval may be a mistake down the line, if you unexpectedly lost your job, for example. Farnoosh Torabi, finance journalist and host of the “So Money” podcast, recommends people not take out a loan payment that accounts for more than 5 to 10% of their monthly budget. Overborrowing can be just as dangerous as paying for something outright that you can’t afford.
Don’t: Skimp on payments
Schedule automatic withdrawals or monthly reminders to pay your personal loan. Payment history accounts for 35% of a FICO credit score, followed by credit utilization, length of credit history, credit mix, and new credit. Missing payments, or paying late, can hurt that credit score and make it difficult to get approved for loans, credit cards, or even apartment leases in the long term. Set yourself up for success now and put that recurring note on the calendar. You’ll thank the future you later.