The Dos and Don’ts of Taking Out a Personal Loan
Although it’s better not to have to take out a loan at all, sometimes it’s the right decision. You might need to deal with an emergency, pay for a large household expense, or just cover a temporary personal cash-flow issue.
If you do need to take out a personal loan, it’s important to do it the right way. Here’s what you should and should not do when you take out a personal loan.
What to Avoid When Taking out a Personal Loan
1. Don’t Take the Loan with the Lowest Rate
The lowest interest rate is always attractive but that doesn’t necessarily mean it’s the best deal. For example, if you hope to be able to repay your loan early then you want a loan that doesn’t charge any early prepayment fees. Some lenders hide high loan origination and arrangement fees under the front of their low APR, so compare the TAR – total amount repayable – and not just the APR rates.
2. Don’t Borrow from Unofficial Lenders
Unofficial lenders might seem to offer attractive terms and rates, but with unofficial lenders you just never know what could happen. Without some kind of official backing, you’re at the mercy of the lender who could suddenly jack up the rates, call in the debt, or sell your debt to another creditor. Make sure your loan provider is legitimate.
3. Don’t Borrow from Friends
Nothing sours a friendship as fast as when one person owes money to the other one. It can get embarrassing to hang out with someone who knows the truth about your financial situation. You might quickly feel like they are questioning you every time you spend money and in turn you can resent them for being in a position of power over you. It’s also common for a friend to change their mind and call in the debt early, leaving you in a worse financial position than before.
4. Don’t Ignore Your Credit Score
You’re unlikely to notice your credit score until you need it, but that’s exactly why you should pay attention to it throughout your life. If your credit score is low because of fraud or a mistake, it’s best to correct that early and not when you’re under stress to find a loan in a hurry.
What’s more, if you apply for a loan without checking your credit score and then get rejected, that will lower your credit score even more. Look up your credit score before you start applying for a personal loan – it’s free – so that you can choose a loan that fits your credit standing. Even if your credit score is low, it’s best to know in advance and approach one of the lenders that offer loans for bad credit instead of risking being rejected for a loan.
5. Don’t Ask Someone to Co-sign Your Loan
Asking someone else to co-sign a loan can seem like a small ask; it’s your loan and you intend to pay it, you just need someone else’s name alongside yours on the contract. However, the dangers of co-signing a loan are well known. It’s likely that whoever you ask really doesn’t want to put their financial security, credit rating, and future on the line but they might not know how to say no.
If you get a loan through cosigning then there’s a good chance that the lender really doesn’t think that you can make payments and expects to have to call on the cosigner to cover the debt. If you can’t get the loan without a cosigner, you shouldn’t take that loan.
6. Don’t Take a Payday Loan
Payday loans are fast, easy to get and you don’t need to provide any information about your financial situation in order to get one. However, they are not without risk. Interest rates for the average payday loan can reach over 300% and the lenders are notorious for pursuing debtors in unpleasant ways. Many payday loan providers demand access to your bank account, which never ends well. Be aware that payday loans are illegal in 13 states.
7. Don’t Provide False Information
Lying or withholding information on your loan application is another major no-no. It’s guaranteed that the lender or bank will find out that you were less than honest with them. When that happens, your loan will certainly be canceled and the truth recorded on your credit score forever.
What to Consider when Taking Out a Personal Loan
In addition to various hot issues that you need to avoid in order to take a personal loan safely, there are some important points to consider when taking out a personal loan.
1. The Type of Loan You Need
Remember, there are both good and bad reasons for taking a personal loan—make sure you indeed need money and the reasons for it. Now you need to consider what is the best type of loan for your needs. The most common type of personal loan for emergencies and temporary issues is an unsecured short term loan. An unsecured loan means that you don’t need to put up anything as collateral against the loan. The advantage is that you don’t risk losing your collateral if you can’t make payments.
A secured loan requires you to put something up as collateral like your house, your car, jewelry, or existing savings and usually has lower interest rates. If you’re confident that you can repay the loan on time then a secured loan will probably cost you less overall.
2. When You Need the Loan
If you’re facing an emergency and you need the money through yesterday, the amount of time it takes to get the loan approved and the funding through is a serious concern. In this area it’s a good idea to turn to an online lender, such as LendingTree, which takes a few minutes to show you potential lenders that match your needs and just a few days to get the funding through. Banks and credit unions tend to take longer to approve and process the loan, up to several weeks in some cases.
3. The Type of Lender
If you’re thinking of getting a personal loan then your first thoughts probably jumped to your bank. However, while banks can often provide lower APRs and better terms, they tend to be slow at processing loan applications and have far higher eligibility requirements than online lenders. Even Financial is an excellent, newer online lender that provides loans to borrowers with lower credit standing.
Online lenders are also usually more flexible in their terms. For example, SoFi is an online lender that allows borrowers to suspend payments for up to 12 months if they run into financial difficulties.
You can also borrow from credit unions, which are more likely to lend to borrowers with poor credit scores. Another option is a peer to peer lending platform like LendingClub, which connects borrowers with lenders so that both sides find a better fit for their financial needs.
4. How You’ll Pay the Loan Off
A key consideration when seeking a personal loan is working out how you’ll be paying it back. Taking out a loan without making a viable repayment plan is asking for trouble. Before you apply for a loan, work out how much you can reasonably expect to spend on repayments each month. If you’re relying on a future windfall like a promised bonus or your salary to pay off the debt in one lump sum, choose a lender like SoFi that doesn’t charge any early prepayment fees.
5. The Repayment Terms
Look beyond the monthly APRs to check what repayment terms each lender is offering, including loan origination fees. LendingClub and GuidetoLenders are among the online lenders that don’t charge any origination fees and penalty charges such as for missed payments or personal check processing fees.
Some lenders ask for weekly repayments while others expect monthly payments. Still other lenders have the flexibility to let you choose whether you’d rather pay off the loan in weekly or monthly installments.
6. The Rates
APR can be either variable or fixed-rate and the best option is always to go with fixed-rate. Variable-rate loans are more likely to go up in interest rates than to come down. With a fixed-rate loan you know exactly what to expect each month.
There’s also the question of whether you’d prefer a short term loan, which is around three years or less in length, or a long-term one. A long-term loan usually brings lower monthly payments, but because the repayment is spread out across such a long period of time you can end up paying more for the loan overall.
7. The Small Print
Whichever of these personal loan lenders you go with, you should always read the small print carefully. Look out for added fees and extras such as loan repayment insurance policies, which will be sold to you as vital for your piece of mind but are actually almost entirely unnecessary.
Keep these tips in mind while deciding on which personal loan provider to go with. To learn more about personal loan providers, read our in-depth reviews.