A personal loan might seem like the only option you have when you need cash urgently. Whether the personal loan is to pay off credit card debt, to buy a home or consolidate debt, a personal loan can be a great solution.
After all, a personal loan tends to offer lower rates than credit cards. However, a personal loan just as any other loans, is still debt, meaning that you will have to repay both the amount you borrowed and the interest on top of it.
Therefore, when you’re considering a personal loan, it is important to understand how it works so it doesn’t impact your financial future. Here are the four common personal loan mistakes to avoid.
Related: Apply for a Personal Loan Today
You Might Also Like:
1. Overlooking the Interest Rates.
One of the biggest personal loan mistakes to avoid is not knowing what the interest rate is going to be like.
It is true that personal loans tend to have lower interest rates than credit cards (the average credit card interest rate is usually between 18 to 22%), but the interest rate of a personal loan is still high comparing to other loans such as student loans or mortgage loans.
For example, the average personal loan interest rates can range from 10% to 28%. That of course will depend on how qualified you are as a borrower, the length of the loan, the loan amount and the lender.
Your credit score is probably the biggest factor when it comes to how much interest you are going to be charged on your personal loan. Obviously, the higher your credit score, the lower your interest rate would be.
Similarly, if you have a poor credit score, don’t expect to have a lower interest rate.
Also, the type of lender you choose for your personal loan will have have an impact on how much interest you are going to be charged.
Traditional banks and credit unions will undoubtedly offer competitive rates. However, non traditional lenders also known as peer to peer lending provide some of the lowest rate out there.
The way peer to peer lending works is that people who have money are matched with people who are looking for a personal loan, through an online platform. These to peer to peer lenders, such as Prosper and Lendingclub, will accept borrowers with a credit score as low as 580 or lower.
So why all of this is important? Well, knowing all of this will give you a better picture of what your interest will be like. Once you have an idea, you can take steps to either increase your credit score or shop around for a better, lower interest rate.
2. Overlooking the Term of the Personal Loan.
A personal loan sounds good because it may offer a lower interest rate than credit cards. However, one thing people fail to realize is that the longer the term of the loan, the more you will pay in interest. Plain and simple.
For example, a $10,000 loan with a 8.75% interest rate and a five year pay off could cost you $4,765 in interest; whereas a loan for the same out, but a 3 year pay off will cost you $2,812 in interest.
Although shorter term loans will generally mean higher monthly payments, but they will have less interest in the long run. Whereas longer terms will lower monthly payments but cost more in interest over the entire life of the loan.
So when shopping for a personal loan, make sure you know the term of the loan. That will give you a clear picture of the difference in interest rates.
3. Overlooking the Origination Fee of the Personal Loan
Whenever you’re taking out a loan, whether it’s a student loan, a mortgage loan, the lender usually charges an origination fee. A personal loan is no different. Origination fees are calculated based on a percentage of the amount you are borrowing, which can be as low as 0.5% or as high as 2%.
For example, if you are borrowing $10,000 with a 2 percent fee, the actual amount of the loan is $10,200 with the fee.
Although a $200 fee may not seem much to some people, but bear in mind that the more you borrow, the higher the origination fee is. So it is important to know what the origination fee will be when considering taking out a personal loan.
4. Overlooking the Terms and Conditions of the Contract Before you Sign.
Some people when they take out a personal loan, will usually sign the contract without even reading what’s in it.
Generally, they will skim the section where is says the amount they borrowed and that’s it. But that is far from enough. A personal loan is a money that you will have to repay and therefore should not be taken lightly.
Not only is it important to read the amount you borrowed, it is equally important to read the term and conditions of loan such as the interest rate, fees, and charges, the amount of repayments and when they are due, and fees for late payments, etc..
So always check the terms and conditions of your contract before you sign it.
You Might Also Like: