5 Mistakes to Avoid When Taking Out a Personal Loan
A personal loan can be a flexible option when you need to cover an unexpected expense or finance a major purchase. You might use one to pay off credit card debt, cover medical bills, renovate your kitchen, plan a wedding, or handle an emergency that comes up without warning.
At the same time, a few common mistakes can increase the overall cost of borrowing. Below are five common mistakes people make when taking out a personal loan, along with tips to help you avoid them.
Mistake #1: Borrowing More Than You Need
Once you're approved for a personal loan, it can be tempting to accept the full amount offered, even if you only need part of it. Lenders may approve you for more than you requested based on your income and credit history. The extra funds can seem appealing, especially if you have other expenses on your mind.
However, every dollar you borrow accrues interest. Taking out a $15,000 loan when you only need $10,000 means paying interest on money that may sit in your checking account or go toward purchases that weren't part of your original plan.
Before you apply, calculate the exact amount you need, down to the dollar if possible. If a lender approves you for more, you can simply borrow the amount that matches your needs instead of accepting the full offer.
Mistake #2: Focusing Only on the Monthly Payment
Your monthly payment is often the first number you'll notice when comparing personal loans. Keeping your payments within your budget is important, but looking at that number alone doesn't show the full cost of the loan.
The interest rate is only one part of the total cost. The annual percentage rate, or APR, includes both the interest rate and certain lender fees. As a result, two loans with the same interest rate can have different overall costs.
The loan term also affects how much you'll pay over time. For example, a 60-month loan often has a lower monthly payment than a 36-month loan for the same amount. However, the longer repayment period means you'll pay interest for more time, which can increase the total amount repaid.
Before choosing a loan, compare the APR and calculate the total amount you would repay over the life of each loan, not just the monthly payment.
Mistake #3: Not Comparing Offers From Multiple Lenders
Different lenders can review the same credit profile and come back with different loan offers. Interest rates, fees, repayment terms, and approval requirements can all vary.
Accepting the first offer you receive, especially from your current bank or credit union, could mean paying more than necessary. A lender you haven't worked with before may offer a lower rate or better terms to earn your business.
Before choosing a loan, get quotes or prequalification estimates from at least three lenders. Many lenders offer prequalification with a soft credit check, allowing you to compare offers without affecting your credit score.
Mistake #4: Not Checking Your Credit Before Applying
Your credit score is one of the first things lenders review when deciding whether to approve your loan application. It also has a direct effect on the interest rate you're offered. A higher credit score may help you qualify for a lower rate, while a lower score can result in higher rates, a smaller loan amount, or even a denied application.
We’d also recommend that you review your credit report before submitting your application. You can get a copy by contacting the three major credit bureaus: Equifax, Experian, and TransUnion. You can also get a free copy of your credit report from each of the three bureaus every 12 months through AnnualCreditReport.com.
Once you receive your report, dispute any errors you find, such as an account that doesn't belong to you or a late payment reported incorrectly. Addressing those issues first may improve the terms you're offered.
Mistake #5: Overlooking Your Ability to Repay
Getting approved for a loan doesn't always mean the monthly payment will be comfortable for your budget. Before you sign, review your monthly income and expenses to see where the new payment fits.
Add up your rent or mortgage, utilities, groceries, insurance, existing debt payments, and other regular expenses. Once you know how much money you have left each month, consider whether the loan payment still leaves room for savings and unexpected costs, such as a car repair or a vet bill.
It's also a good idea to leave some room in your budget for changes in your finances. Your income could change, and unexpected medical expenses or other bills can come up. A payment that seems affordable today may become harder to manage if there's little money left at the end of the month.
Only accept a loan if the monthly payment fits comfortably within your current budget, not the budget you hope to have six months from now.
Read also: Is a Personal Loan the Right Choice for Debt Consolidation?
Before You Sign a Personal Loan
Before you commit to a personal loan, calculate how much you need, compare offers from multiple lenders, look beyond the monthly payment, and review the total cost of the loan.
You should also confirm that the monthly payment fits comfortably within your current budget. Spending a little time reviewing your options before you sign can help you avoid unnecessary costs and financial stress later.
At First Pioneers, we care for our members and provide more than financial products, including personal loans. We also share financial information to help you make informed borrowing decisions.
If you live, work, worship, or attend school in Acadia, Beauregard, Calcasieu, Cameron, Iberia, Jefferson Davis, Lafayette, St. Landry, St. Martin, St. Mary, or Vermilion Parish, First Pioneers is here to serve your financial needs. Visit one of our branches in Lafayette or New Iberia, or give us a call to learn more.