Personal loans can provide you with funds to pay off credit cards, purchase new household appliances, pay for home renovations and more.
But it's easy to make decisions about your loan that can hurt you financially for years to come.
Here are four common mistakes consumers make when shopping for a personal loan, and what you can do to avoid them.
1. Accepting the First Loan Offered
Loan terms aren't set in stone, so you may not want to just accept the first loan offered to you. Instead, do these two things to help ensure you receive favorable terms:
- Shop around. It's great if you get approved at the first bank you walk into, but that doesn't mean they're offering the best possible terms. Obtaining a personal loan is a major financial commitment, so consider looking at your options before making your decision. Just be aware that if you apply for multiple loans within a short period of time, these inquiries will show on your credit report - however, they will typically count as one inquiry if they're made in a short period of time.
- Negotiate loan terms. There's no rule requiring you to accept the loan terms you're offered without a little pushback. That said, lenders aren't obligated to negotiate or change their terms for you, either. Make sure you have a clear idea of what loan terms are acceptable to you--such as length of the loan and the monthly payment amount--so you can go into negotiations with a game plan.
2. Ignoring Credit Eligibility Requirements
A credit check is typically a standard part of the loan approval process. There are hard and soft credit inquiries:
- A hard inquiry generally occurs when a creditor (such as a bank or credit card issuer) checks your credit report in order to make a lending decision.
- A soft inquiry generally occurs when you check your own credit or when another person or company checks your report for the purpose of credit pre-approval or as a background check.
With every hard inquiry, your credit score may go down by a few points. Do this too often over an extended period of time and your credit score may take a significant hit. Hard inquiries may remain on your credit report for two years.
3. Overlooking the Fine Print
Before signing your loan agreement, make sure you understand every detail of your loan. While you should read all the fine print thoroughly, the following two things can be particularly important to know:
- Interest rate and loan duration. Both the interest rate of your loan and how that interest is calculated are important pieces of information to know. Interest generally compounds for the duration of your loan, so the longer the loan, the more you're going to pay in interest. Paying off $10,000 over five years may give you low monthly payments, but you'll typically pay more in interest than if you pay off the same amount over one or two years.
- Fees and penalties. "The biggest personal loan mistake consumers make is not paying attention to all of the fees," says Roshawnna Novellus, president of Novellus Financial. For example, origination fees (a fee that your lender may charge to cover the cost of processing the loan) may usually be tacked onto the principal of the loan, and can be up to 5 percent of the loan amount. And an exit fee--or pre-payment penalty--is often charged if you pay the loan off early; the amount may vary depending on the amount of your loan. So before you sign on the dotted line, read through the agreement carefully.
4. Borrowing More Than You Can Afford
It can be tempting to take the most amount of money possible on a personal loan. However, even if you can afford the payments today, your financial situation could change at a moment's notice and those payments could come back to haunt you. Interest builds up over time resulting in increased payments, which could wreck your finances if you come up against difficult times.
One way to avoid this is to decide on an exact number for your loan before you go into negotiations. If you only have a vague idea of how much money you want to borrow, the loan officer may try to convince you to raise the amount of the loan. Having a clear, reasonable amount in your head can help you avoid accepting money that you may have trouble paying back.
These are four major mistakes that people make when applying for a personal loan - but you may be able to avoid them if you shop around for the best loan possible, be aware of your credit score before applying, read the fine print, and borrow only as much money as you need.
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