Personal loans can be a great financial resource for several reasons. Borrowers typically use these funds to tackle debt consolidation, education expenses, medical expenses, and more.
But like anything else involving your finances, it helps to do a little research ahead of time. Many people make a handful of mistakes when it comes to looking and applying for the best personal loan. To get you on the right track, we spoke to Amplify Credit Union’s Consumer Lending Manager, Kevin Garraway.
We’ve condensed some of his wisdom into this handy article to help you avoid some of the most common personal loan mistakes.
Mistake #1: Failing to Read the Fine Print
Before signing the dotted line, make sure you are aware of everything in the fine print. This review process includes all fees and extra charges that the lender may not be too eager to disclose.
Kevin Garraway gives one example of this. “It is important to know when the late charge is assessed and how much it is. This can be very high on some types of loans, so it is best to read this section of the contract.”
In addition to late fees, you should also know when and how much you will pay for charges. Be sure to ask questions about:
- Prepayment penalties
- Origination fees
- Closing costs
- Service fees
These are often hidden and tucked away in the contract, so read thoroughly.
Mistake #2: Applying for Too Much Credit
Have you recently made a big purchase using credit? You may want to rethink applying for a personal loan for a bit. Trying to take out too much credit at once can hurt your financial standing.
“Applying for too many loans can lower your credit score,” Garraway explains. When you apply for a loan, the lender will perform a hard inquiry on your credit. Hard inquiries will generally be taken when you do things like:
- Apply for financing at a car dealership
- Apply for a credit card
- Apply for a loan of any sort
- Request a credit line increase
Unlike soft inquiries, these credit pulls can damage your score, affecting your ability to get credit in the future.
“Having access to a large amount of unsecured debt can cause problems,” he continues. If you already have a large loan or a revolving line of credit, it may raise questions with the lender. “If a borrower has a $60k available limit on revolving credit cards,” Garraway adds, “a lender may wonder why they are applying for an additional revolving balance.”
Mistake #3: Failing to Shop Around for the Best Rates
Interest rates matter when applying for personal loans. They could mean the difference between paying hundreds and paying thousands in interest alone over the loan term.
Comparing lenders is essential. Just by doing a little research, you can find out if the terms of the loan will work in your favor. Rates and loan terms can vary from one individual to the next, depending on your unique credit situation and history. In some cases, you may be able to get a better rate or loan amount simply because you have an existing relationship with the financial institution.
Interest rates aren’t the only item on the shopping list. It also helps to work with a financial institution that you can trust. You can’t put a price on customer service and helpful loan servicers.
Mistake #4: Considering Only the Monthly Payments
Some people may read the fine print and look at the additional fees but fail to consider them when comparing different loans. While you want to look for the best interest rates, make sure that you factor all costs into your calculations.
While your monthly payment will be lower with a particular loan because of the rate, you may end up paying more in the long run because of the various fees.
Mistake #5: Thinking You Must Be Prequalified
While getting prequalified allows you to compare interest rates, some borrowers think that prequalification gets them a better deal. This is not the case.
Prequalification means that the lender has looked over your information and is (conditionally) willing to lend you a certain amount at a certain interest rate. When it comes to personal loans, getting prequalified does not carry as much weight as with other loans.
“This is not as important to do since these loan decisions are generally made within 24 hours,” Garraway explains. “Unlike a car loan, you do not gain advantages in a purchase situation.” So don’t move forward with the first prequalified loan you secure. Again, take your time and do more in-depth research.
Mistake #6: Using an Unsecured Loan as a Source of Income
Sometimes, borrowers use personal loans as a source of income. This is more common with freelancers or self-employed individuals who may use the funds to cover the low points in their cash flow. Garraway recommends that businesses and individuals avoid this.
“It is so easy to let unsecured loans get out of hand,” Garraway explains, “so this should rarely be used for a source of income during downtimes. If this is being used for cash flow issues, then many financial institutions have business loan lines of credit available.”
No matter when you take out your loan, it is important to keep one eye on your repayment plan. “It is always best to not pay minimum balances on revolving debt to reduce interest charges,” Garraway reminds us. “Depending on the rate, some revolving debt can take well over 20 years to pay off the balance making minimum payments.”
Mistake #7: Not Looking at Your Credit Standing Before Applying
We mentioned this earlier, but your interest rates are dependent on your credit situation. That means if you apply when your credit score is less than stellar, you can face higher interest rates than necessary.
Checking your credit before you apply is a smart way to evaluate your appeal as a borrower. If your score is below 660, hold off on a personal loan until you’ve spent some time raising your credit score. Keep an eye on your credit reports and apply when your score has gone back up.
Be in the Know Before You Apply
Always do a little homework before taking out a personal loan. Knowing these seven personal loan mistakes before you begin your search can save you money and headaches down the road.