Versatility. It’s one of the chief attributes that can make a personal loan attractive.
You can use it to consolidate debt, finance a vacation or build a new addition on your home. But it’s not free money, so you should take seriously your decision to apply and investigate options before making a decision, says Tara Alderete, director of education for ClearPoint Credit Counseling Solutions, based in Atlanta.
“When you’re seeking a personal loan, think about why. What’s your goal? What do you want to do?” she says. If you can accomplish your goal by budgeting for it, that’s better than taking out a loan.
But if you decide a loan is necessary, don’t make a decision in haste. That can prevent you from getting the cheapest financing available to you. It also could mean lenders will reject your application.
Avoid these 5 mistakes to improve your chances of getting a loan that’s right for you — and to keep your finances healthy afterward.
Taking out a personal loan might itself be the mistake. Consider all your options first.
If you’re consolidating debt, you might consider opening a new credit card and transferring the balance of your other cards to it, particularly if you can grab a 0% introductory offer.
You won’t find a no-interest personal loan offer, and even with fees you’ll pay to transfer your balance, you’ll still come out ahead with a credit card. But you have to be disciplined, and you have to have good credit.
“Generally speaking, the people who can qualify for these 0% offers and really competitively priced personal loans, they’ve got good credit,” says John Ulzheimer, a credit expert who formerly worked at credit companies FICO and Equifax. “These things aren’t just being given out to people who have mediocre credit scores.”
One other note of caution: If you’ll still have a balance once the intro period ends, you might be asked to pay interest retroactive to the day you opened the account, Ulzheimer says.
Another downside: Opening another credit card and using a large chunk of your available credit on that card with the balance transfer, could hurt your credit score in a way opening a personal loan wouldn’t.
“Credit-scoring systems do not like revolving debt,” Ulzheimer says. “It’s high-risk debt and it’s very impactful on your credit scores, and not in a good way.”
How expensive is a bad credit score? It could cost thousands of dollars in finance charges.
Lending Club, one of the big online personal loan firms, says its average interest rate is set between 7.13% and 29.25% based on creditworthiness. The less of a risk you are perceived to be, the cheaper your personal loan will be.
Here’s a little math problem to put those percentages into perspective. If you took out a 3-year, $10,000 personal loan that charged an interest rate on the low end of Lending Club’s scale, you’d pay $1,137 in interest. That same loan with the higher interest rate would cost you an additional $4,000 in interest.
You should check your credit score before applying for any loan – and do some work to raise that score if it’s low.
“If you are unpleasantly surprised by how low your score is, then you can take some action such as paying down some cards, if you can do that,” says Barry Paperno, former consumer affairs manager for FICO, who now runs the blog SpeakingOfCredit.com.
After you’ve paid down some debt – or simply began compiling a good record of on-time payments – take a fresh look at your score to see if it’s improved enough for you to qualify for a lower interest rate.
Just as a bad credit score can cost you, taking the first loan offer that comes your way can make your loan unnecessarily more expensive.
“Go to the group you know first, but definitely shop around,” Alderete says.
You can start with your bank or credit union, she says, but then look at nearby competitors. Don’t forget to look at offers online, too.
The cheapest loan offers found on Bankrate range from 5.99% to 10.8%, for example, for borrowers with excellent credit.
Make sure to look at the fees associated with the loan, as well, Alderete says. Some lenders charge origination fees that can range from 1% to 6% of the loan. The fee typically is deducted from the loan amount, meaning you won’t actually receive $10,000 when you apply for a $10,000 loan.
Don’t think that overstating your income on a personal loan application will get you a better deal. It could harm your chances for getting a loan. And it’s illegal.
Lenders don’t always check that you’re telling the truth on a loan application, but when they find out your information is inaccurate — whether by accident or intentional — they can deny the loan.
For example, online lender Prosper Marketplace says that over a nearly 7-year period it canceled 12% of loans that had been approved but not yet funded after finding “inaccurate or insufficient employment or income information” during the verification process.
What’s more, if a lender finds out after it has issued the loan that you lied on your application, that could be considered a loan default. Making a “material misrepresentation” on a loan application is cause for the lender to “demand that borrower immediately pay all amounts owed,” according to the Lending Club’s borrower agreement.
You can still make mistakes even after you get your loan money. Here’s the top mistake for people who take out a personal loan to consolidate high-interest credit card debt: failing to change money habits.
“If you go the consolidation route and don’t address the behavior, it’s going to be a problem,” says Thomas Nitzsche, a certified credit counselor and spokesman for ClearPoint Credit Counseling Solutions.
Shifting the debt from your credit cards to a personal loan frees up those credit cards for more spending. If you don’t control your spending, you could end up in a worse financial situation than you were in before you took out a personal loan, Nitzsche says.
Make sure you look at your budget before and after taking out a loan, Alderete says. Can you afford the fixed monthly payments that come with a personal loan? What can you do to cut expenses so that you won’t end up with even more debt after you get that loan? Can you trim enough from your budget to be able to repay the loan faster than you are required?
If you can’t afford the loan, your credit card balance may increase and you may have trouble making timely payments. That will damage your credit score.
“Don’t let the balances creep up to where the utilization (rate) is big because that will hurt your score,” Paperno says.