“Not having a good credit score doesn’t necessarily preclude you from getting a loan, but it can prevent you from securing the low end of the interest-rate range,” says Brendan Coughlin, president of consumer lending at Citizens Bank.
Here’s how big a difference in rates a credit score can make: A $10,000 loan paid back over 4 years by consumer with a low credit score could have a rate of 30.02%; that borrower would have to pay back $17,289.
But a consumer with a higher credit score might get a 9.66% interest rate and pay just $12,096 — a difference of $5,193.
Because a higher score can help reduce the overall cost of a personal loan, building your credit before applying for financing can go a long way.
“If you’re carrying debt, come up with a plan to pay that off and try to not add to that existing debt,” Coughlin says. “But more importantly, make your payments on time. Nearly one-third of your credit score is based on your repayment habits.”
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Myth: All lenders charge the same
Lenders vary significantly on fees and rates for personal loans.
When comparing loans, “a lot of people make the mistake of going by interest rate,” says Harrine Freeman, CEO and owner of H.E. Freeman Enterprises. This can be misleading because some lenders charge additional fees.
To get a true idea of the cost of a loan, look for items such as origination fees. These are charged by some lenders and usually range from 1% to 5% of the loan total, says Andrew Housser, co-CEO of Freedom Financial Network.
Also, check for fees for unsuccessful payment, which occurs if your payment is set up to be automatic but the payment is rejected.
Some lenders also charge fees for processing checks and late payments. There might even be a prepayment penalty, a fee you’ll be charged if you pay off the loan ahead of time.
In addition to reading the fine print, ask about the TAR, or total amount repayable, on a loan.
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Myth: Your house is used as collateral
Lenders generally offer personal loans as an unsecured loan, which does not require collateral.
If you take out a secured loan, you’ll need to put up collateral, such as your home, auto, or something else of value, Freeman says. This way, if you can’t pay the loan or you stop making payments, lenders are able to recover their loss.
Because of the required collateral, lenders view secured loans as less risky, and thus offer lower interest rates on secured loans.
With an unsecured loan, the interest rate usually will be higher, but you won’t have to put your car, house or other valuable items at stake.
If you’re unable to pay off a personal loan, a lender likely will report the missed payments to one of the credit bureaus. Your credit score will take a hit, but you won’t lose your home.
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Myth: Personal loan is priciest loan type
Although the interest rate on a personal loan may be higher than the rate on a secured loan, it is still considerably cheaper than other types of financing.
You’ll get a better rate on a personal loan than you will on a cash advance or payday loan, which consists of funds lent at a very high interest rate and paid back when you receive your next paycheck.
The lower rate on a personal loan may not be exceptionally low, but savings can add up over time. Let’s say you have a credit card with a 20% interest rate. If you repay $10,000 over 60 months, you would pay about $265 per month. The interest would come to $5,896.
If you have a $10,000 personal loan with an interest rate of 16% over a 60-month time frame, you would pay about $243 each month. The total in interest would be $4,591. With this option, you save about $1,305 in interest.
Another cost-saving advantage of personal loans involves having the funds in your hands. This can work in your favor, especially if you’re buying a car or making changes to your property.
“Our borrowers make purchases as a cash buyer,” LightStream’s Nelson says. “You can often negotiate a better price if you have all the money upfront.”
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Myth: A personal loan is best way to pay off credit cards
Since personal loans tend to offer lower interest rates than credit cards, it may seem that taking out a personal loan and paying off all your credit card bills and making payments for just the personal loan is the best way to proceed.
Before doing so, it’s important to evaluate your debt. For instance, if you’re unable to make minimum payments on current debt, you might not qualify for a personal loan, Housser says. In that case, you might be better able to clear the debt through a debt settlement or credit counseling.
Also, look at the time frame of your debt. “For those able to repay their debt in less than a year, it probably does not make sense to refinance debts with a personal loan,” Housser says. This is because of the origination fee often charged with personal loans; it could end up canceling out the savings a lower interest rate will bring.
Still, if you’re looking at much more than a year of payments, a personal loan may help.
“For someone knowing it will take longer than a year to pay off the debt, then it’s possible to save significantly with a personal loan, even after paying the origination fee,” Houser says.