Making a personal loan work for you involves planning and management.
- Shopping around for the right personal loan is crucial.
- Using a personal loan to consolidate debt only works if you don’t take on more debt.
Personal loans can be a great way to consolidate debt or pay for a big home improvement project, but there are a few things to watch out for when taking out a personal loan.
1. Missing out on a better deal
It’s easy to believe that one lender is as good as another, but nothing could be further from the truth. Lenders compete for your business, and it’s up to you to find the lender with the best deal.
If you’re worried that seeking loans will negatively affect your credit score, there’s no reason. Credit bureaus like TransUnion, Equifax and Experian expect consumers to seek out the best loans. If you make your loan purchases within a relatively short period of time (two weeks, to be sure), it shows up on your credit report as one request. For example, if you apply for a personal loan from seven different lenders during this time, your credit report will show that you applied to only one lender.
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The point is this: whether you have a very high credit score or a not so good credit score, the interest rate and terms offered by different lenders differ. If you automatically accept the first lender’s offer, you could spend thousands of dollars more than with another lender.
2. Borrow more than necessary
When you take out a loan, it is tempting to fall into the trap of borrowing as long as the lender tells you that you are qualified to borrow. Let’s say your bathroom was last renovated during the Truman administration and it really is high time for an upgrade. You plan to borrow $25,000, but are told you can easily qualify for $40,000. Suddenly you think about how you could use the extra money.
One of the fastest ways to turn a positive loan experience into a bad one is to borrow more than you need. For example, if you were to borrow $25,000 for four years at an interest rate of 9%, your monthly payment would be $622 per month and you would pay a total of $4,862 in interest. Accepting the extra $15,000 means your monthly payment would be $1,120 and you would pay $8,752 in interest.
At the end of the line : Borrowing more than needed to meet your original goal would cost an additional $3,890. That’s nearly $4,000 that you could have invested for the future or set aside for a bad day.
3. Not reading the fine print
It’s in the fine print that you’ll discover the details that can impact your life. For example, you’ll want to know if there’s a prepayment penalty, how much you’re paying in set-up fees and other added costs, and if credit insurance is available.
Once you’ve decided to take out a personal loan, it’s easy to skip the fine print to get to the good stuff – loan funding. But if you don’t want to regret the loan once the funds are in your bank account, read the fine print first.
4. Not creating a budget that works
Before the pandemic hit US shores in 2020, 3 in 10 adults didn’t have a monthly budget. Now that number is closer to 2 out of 10. Unless your monthly budget is accurate, taking out a new loan can be dangerous.
Let’s say your loan has a monthly payment of $500. At first glance, your income should be more than enough to cover your expenses. However, if you don’t factor in a month with abnormally high utility bills, trips to the emergency room, or a broken down car, it could be difficult to repay the loan when due.
It’s impossible to plan for every eventuality in life or anticipate every little thing that can go wrong, but budgeting that works means accounting for unforeseen expenses. This way, you can still make your loan repayment, even when surprise bills appear.
5. Getting into trouble again
One of the best uses for a personal loan is debt consolidation. If you have high interest debt, getting a personal loan with a lower APR can save you thousands of dollars. However, if you use a debt consolidation loan to pay off your existing debt, then buy a new car or max out your credit cards, you’ll be worse off than before the consolidation.
Personal loans can be a great financial tool for achieving your goal – as long as you are in control from the time you apply until the day the loan is paid off in full.
The Ascent’s Best Personal Loans for 2022
Our team of independent experts have pored over the fine print to find the select personal loans that offer competitive rates and low fees. Start by reviewing The Ascent’s best personal loans for 2022.