Common Personal Loan Mistakes to Avoid
Personal loans are not the most commonly-used form of borrowing, so it's easy to make errors when shopping or applying for a personal loan. Personal loan mistakes can be very expensive, however, so read these tips before borrowing. With just a little knowledge, you can have a successful personal loan experience.
#1: Choosing the Wrong Loan
The biggest mistake many make is not choosing a personal loan when it's their best option. Many consumers don't understand personal loans and have never applied for a personal loan, unsecured loan or signature loan. But personal loans have many advantages over more common financing choices.
Probably the biggest advantage is that they come with fixed interest rates and payments. That makes budgeting and understanding personal loans easy. And they are installment loans, which means that as long as you make your monthly payment on time, you will pay your loan off exactly when the documents say you will.
Personal loans are faster and easier to get than home equity loans, and your home is not on the line if you can't repay the debt. Finally, personal loans are usually good for your credit score. They don't increase credit utilization like credit card debt does, and paying your personal loan as agreed adds good repayment history to your credit report and score.
On the other hand, for borrowing very large sums of money, home equity financing can be cheaper. And for borrowing very small sums, credit cards will do just fine.
#2: Borrowing Too Much
Getting approved for your first personal loan can be a heady feeling - all that money for you do spend as you please. But just because a lender is willing to lend you X doesn't mean you should necessarily borrow X. The metric that lenders use to decide if you can afford their loan - the debt-to-income ratio or DTI - does not consider a host of things. For example, child care costs, utilities, the cost of your commute, hobbies, your plans for saving, your medical condition, your charities and other costs that are none of their business.
But those costs are your business, and only you can decide if a loan is truly affordable. When examining a personal loan, look at the monthly payment and ask yourself where that money will come from. What will you give up? Borrowing too much and having an unaffordable payment can cause late and missed payments, and your credit score to plummet. Unpaid personal loan lenders can sue you and get a judgment against you, which creates a public record. This could interfere with employment applications, raise insurance premiums and possible even lead to bankruptcy,
Most personal finance specialists recommend borrowing only what you need and paying it off as quickly as you can afford to.
#3: Only Comparing Payments
Personal loans are not especially complicated, but you do need to pay attention to all of their components, including:
- Loan amount
- Interest rate and type
- Loan term (months or years)
- Personal loan fees
When comparing personal loans from competing lenders (something you should definitely do), provide all lenders with the same request: the same loan amount and term. You'll also want to give them all the same information about your credit score, income and debts. The better the information you give the lenders, the more accurate their quotes will be.
One lender may offer the lowest payment, but its fees could be much higher. Or the loan term could be longer. It's easy to quote a lower payment when you just extend the repayment for a few extra years.
When comparing personal loan offers with different interest rates and costs, APR or annual percentage rate can be helpful. Just make sure that you use it to compare loans with the same term or it won't be accurate.
#4: Not Knowing Your Credit Score
Before you look for the best personal loan for your situation, you have to know what your situation is. Your credit score is a big part of that because most lenders market to consumers in specific credit tiers - poor, fair, good and excellent. You're wasting time (and potentially harming your credit score) by applying to lenders that don't work in your space.
In addition, knowing your credit score is important when shopping for a personal loan. You can provide competing lenders with this information so they can give you realistic offers.
And finally, checking your credit report and score can help you detect credit report errors and fix them before you apply. Your loan application will go more smoothly and you'll avoid embarrassment.
#5: Not Shopping for Better Terms
Inexperienced borrowers can be so nervous about applying for a loan that they are grateful for any loan approval. Even if the loan they're offered is not the greatest. And those who have been turned down before may be so shell-shocked by the experienced that they assume that only bad credit personal loans are available to them.
How do you know if an offer is fair? By getting more than one offer. You can contact several lenders through this site and see what each one is willing to do for you.
One warning, however - when getting your offers, provide every lender with an estimated credit score (that's why you checked your own credit) and don't authorize a "hard pull" until you're ready to do business. That's because credit reporting agencies treat personal loan and credit card inquiries differently than they do mortgage or auto financing inquiries. Mortgage and auto inquiries pulled within a short time-frame get combined and only hit your FICO score once. But every "hard pull" for personal loans or credit cards dings about five points from your score - which can drop you into a less-desirable credit tier.
How to Find the Best Personal Loan
The best personal loan for you is one offered by lenders that want to compete for borrowers like you. That means consumers who share your credit profile, debt-to-income ratio, loan amount and loan term. So compare lenders and see what dollar amounts they lend, the range of interest rates they advertise, the loan lengths they offer and the minimum FICO scores they accept.
Next, ask several likely candidates to make you an offer based on your loan amount, term, credit score, etc., and choose the most attractive from there. Personal loans are really simple financial instruments compared to credit cards and mortgages and auto loans. Once you know what to avoid you can make a confident personal loan decision.