13 Common Personal Loan Mistakes to Avoid
When you’re in need of cash and considering a personal loan, the prospect of choosing one out of dozens of available lenders and trying to suss out the best offer on the table can be daunting.
Before you decide to move forward, there are quite a few mistakes we’d like to help you avoid, from making sure you qualify for a competitive interest rate to not paying too much in fees to making sure you need a loan in the first place.
13 personal loan mistakes to avoid
- Not checking your credit first
- Not getting prequalified
- Not comparing options from more than one lender
- Not paying attention to the APR
- Not reviewing potential fees
- Not taking the loan term into account
- Not reading the contract
- Using your personal loan for something frivolous
- Applying for too much credit at once
- Not considering a cosigner
- Making late payments
- Not repaying the loan
- Not considering alternative options
1. Not checking your credit first
When applying for a personal loan, your credit health and financial information will heavily influence whether you qualify and the kind of loan terms you receive. Checking your credit then can help you suss out lenders you may be eligible with before you ever apply for prequalification. (More on that below.)
To review your credit reports with each of the three major credit bureaus, visit AnnualCreditReport.com. If you want to just see your credit score, you can do so by using My LendingTree without affecting it. You can also learn more about the factors influencing your score, how to boost savings and more.
Once you have your credit reports in hand, give them a close look. You’ll want to identify and dispute errors, such as out-of-date debt information.
2. Not getting prequalified
With prequalification, you submit a preliminary application with a lender in order to see whether you’d likely be eligible and, if so, for what kinds of terms. The prequalification process allows you to more thoroughly compare lenders, though not all lenders offer prequalification.
Most lenders perform a soft credit check during the prequalification process, which won’t impact your credit. When you visit a lender’s website, you’ll likely get the option to “check rates.” When submitting an application for prequalification, you’ll provide simple information, such as your income and housing situation, plus how much you want to borrow and for what purpose.
You can also use a loan marketplace like LendingTree to potentially receive multiple loan offers with one application. If you prequalify with one or more lenders, you’ll get to see the kinds of terms you may be able to get.
However, while prequalification is a great method to compare lenders, it’s no guarantee that you’ll get a personal loan when formally applying.
3. Not comparing options from more than one lender
Personal loans are just that: personal. Each lender offers different loan terms and has their own method of evaluating your credit profile. Settling for the first loan you find means you could miss out on another lender’s lower interest rates, more flexible loan terms or better customer service.
If you have good to excellent credit, APRs on personal loans may start as low as 4.99%. Borrowers with fair or bad credit may see APRs of 35.99% or higher.
A strong job history and low debt-to-income ratio may help you qualify for a more affordable personal loan. To find competitive personal loan terms for your financial situation, check prequalification offers from at least three lenders.
Compare factors such as:
- Available loan amounts
- Range of repayment terms
- Interest rates
- Fees, such as an origination fee
Ideally, you’ll find a lender that minimizes your cost of borrowing.
4. Not paying attention to the APR
When you’re shopping for a personal loan, you’re probably laser-focused on the monthly payment to be sure you can afford it. But don’t stop there — the APR, or annual percentage rate, is a more accurate measure of your loan cost; it includes the interest rate plus other loan fees, such as an origination fee. If there are no fees, the APR equals the interest rate.
Once you have an estimated APR or range of APRs from prequalification offers, you can use a personal loan calculator to see the potential costs you can expect on a personal loan over its repayment period.
5. Not reviewing potential fees
Personal loans may come with extra costs, from origination fees to prepayment penalties and late fees. Not all lenders charge fees, but if you don’t check for them, you could end up with a surprise down the road. Before signing for the loan, ask about any fees involved and when the lender charges them.
- Origination fees are a common personal loan fee and can range from 1% to 8% of the loan amount. It is either deducted from your loan proceeds or added to the principal balance. For example, a 4% origination fee on a $10,000 loan would cost you $400.
- Prepayment penalties are charged when you pay off the loan before the repayment period is up. The amount of the penalty and the conditions that trigger the fee can vary by loan and by lender.
- Late fees are charged when a payment is overdue, either as a dollar amount or a percentage of the overdue payment. The lender may also report a late payment to the credit bureaus after 30 days, which can impact your credit scores.
6. Not taking the loan term into account
The loan term, or repayment period, is the number of months over which you’ll repay the personal loan. Personal loans with a shorter term usually have higher monthly payments, but lower overall interest charges. A longer term means lower monthly payments, but a higher overall cost to borrow.
7. Not reading the contract
Too often, people sign things they haven’t read. Make sure you take your time reading the fine details when taking on debt. If you encounter a lender with a costly personal loan product, reviewing their fee structure and conditions can reveal hidden fees. For example, many lenders don’t charge a prepayment penalty. But this type of fee can be costly if you plan to get out of debt sooner.
That said, your lender should disclose all the terms of the loan. If you have questions or uncertainties, you should feel welcome to ask questions. Further, it’s important to double-check for any mistakes on your loan application. Honest mistakes may be understandable but can affect your loan eligibility and terms.
8. Using your personal loan for something frivolous
A low-cost personal loan to pay for a vacation or luxury purchase could be more affordable than charging the expense to a credit card, but that doesn’t make it the best decision for your money. Taking on the liability of a loan to cover a nonessential expense could come back to haunt you — especially if you find you’re unable to keep up with the payments.
Good uses for personal loans include consolidating debt or to cover emergency expenses. That’s because debt consolidation may allow you to repay your debt for less, while emergency expenses are necessary but can be so costly that you can’t pay them out of pocket.
9. Applying for too much credit at once
Don’t buy a house, boat, car or other major purchase on credit right before applying for a personal loan or while you’re in the process of getting the loan. Taking out additional credit before or during your personal loan inquiry may hurt your chances of qualification. In addition, taking out a personal loan while you’re in the process of closing on your mortgage isn’t a good idea either.
Make sure you’re only applying for one loan at a time, and give it some time before you attempt another inquiry on your credit for some other purpose.
After you receive the loan funds, keep an eye on your spending. If you’ve consolidated debt under one loan but keep adding to your credit card balance, you may be pushed further underwater. Juggling two types of debt can make it harder to pay off the loan.
10. Not considering a cosigner
Not everyone needs a cosigner, and there are many pros and cons for both you and the person cosigning a personal loan. On the plus side, a cosigner can help you qualify for the loan and get a more desirable interest rate. However, the cosigner bears a lot of burden here: They’ll be responsible for payments if you can’t make them, and missed and late payments will affect both your and your cosigner’s credit.
Consider these benefits and drawbacks before asking someone to cosign a loan. If your credit is poor, it may be a good idea to have a cosigner ready on the sidelines.
11. Making late payments
While on-time payments can help improve your credit, late payments adversely affect your credit scores. Depending on the loan terms, you also might have to pay a late fee if the payment is overdue — which increases your overall cost of borrowing. The late fee may be charged as a dollar amount, or a percentage of your unpaid monthly payment, though the exact amount will vary by lender. Some lenders, though, don’t charge them at all.
To avoid late payments, set up a calendar alert a few days before the payment is due. The lender may also let you sign up for automatic payments withdrawn from your checking account. (Some lenders will even provide a discount on your APR for doing so.)
12. Not repaying the loan
You may be wondering: What happens if you don’t pay a personal loan? The truth is, nothing good.
When you become late on payments, the lender may report the account as delinquent to the credit bureaus. This will cause a negative mark on your credit. Continue to miss payments for 90 days or more and you’ll default. By this point, you’ll likely be receiving calls for a payment. Not long after, you can expect the lender to send the loan to a collection agency.
If the loan falls within the statute of limitations, the lender may also go to court and request a judgment to garnish your wages, place a lien against your property or get the funds from your bank account.
13. Not considering alternative options
Don’t make the mistake of thinking a personal loan is the best option out there. For example, if you have good credit, you could seek out a credit card with a promotional APR offer.
Credit card issuers commonly offer cards with a promotional 0% APR to draw in new customers. These offers typically last 12 to 18 months, and can be a great way to consolidate debt or make a major purchase for less, so long as the balance is repaid before the offer ends. (If you don’t, you could be hit with deferred interest from the purchase date.)
If you have fair or bad credit, you’re liable to see lower loan costs with a secured loan. They can be easier to qualify for too, as there’s less risk for the lender. Secured loans are backed by collateral, meaning if you fail to repay the debt the lender can seize the asset.