Personal loans can be a financial godsend to pay down or consolidate debt, fund future travel plans, finance a home improvement project, or meet other needs.
Understanding how personal loans work and what to look for can help lead you toward the right lender and personal loan. There are also some things you want to watch out for when you take out a personal loan.
Below are ten common personal loan pitfalls to avoid when looking for a personal loan.
Not Shopping Around
When looking for a personal loan, it’s important to compare lenders to find the right option that fits your needs.
Applying with the first lender you find could mean missing out on better rates or other loan benefits.
Many lenders allow you to check rates or prequalify for a loan through a soft credit check, which won’t affect your credit score. Then, you can compare lenders and loan options to find one that suits your needs.
Pay attention to rates, loan fees and penalties, minimum and maximum loan amounts, loan terms, and other factors.
Borrowing More Money Than Necessary
Just because a lender allows you to borrow a certain amount doesn’t mean you should take out a loan for that much.
Lenders charge interest on personal loans.
Borrowing more than you need leads to expensive interest charges and higher monthly payments. It could also extend you financially beyond your current budget and lengthen your loan repayment.
People take out personal loans for various reasons, including to pay down existing debt, fund a vacation, home improvement project, or event, and finance large purchases.
The amount you need depends on your reason for borrowing money.
Determine how much you need to borrow and find a lender that allows you to borrow that amount.
You can borrow a little extra if you need some wiggle room for increased costs, but try to keep the loan amount close to your actual need.
Not Paying Attention to Loan Fees
Your monthly loan fee may not be the only cost associated with personal loans.
Some lenders charge additional fees on personal loans.
Fees vary between lenders and can undermine repayment efforts or cut into available loan funds. Common personal loan fees include:
- Application fee
- Prepayment penalty
- Origination fee
- Late fee
- Payment processing fee
Read through the fine print in the loan terms and conditions before you sign the dotted line.
Make a note of what loan fees your lender charges and which ones are avoidable.
Sign up for automatic payments if your lender offers the option to avoid costly late fees.
If you haven’t applied for a loan, include fees in your checklist when comparing lenders. Choose a lender that charges little to no fees when possible.
Find the best personal loans without fees and compare rates.
Thinking Prequalification Means You’re Approved for a Loan
When you prequalify for a personal loan, the lender performs a soft credit inquiry, which is a basic assessment of your creditworthiness.
Prequalification gives you an idea of whether you will be approved for a loan through a particular lender and the rates you may receive when you apply for a loan.
Soft credit inquiries don’t tell the whole story, though.
When you apply for a loan, lenders perform a hard credit inquiry, which dives deeper into your credit history, giving lenders a complete picture of your credit and financial health so they can make a more informed decision.
Even if you prequalify for a loan, there’s no guarantee that you’ll ultimately be approved by the lender or receive the same interest rate.
A deeper look into your credit and financial history could reveal some red flags that make you a greater lending risk.
Prequalifying for loans is a good idea so you can see possible rates. Just know there’s no sure then until you’ve officially applied and been approved for a loan.
Not Checking Your Credit
Lenders approve loans and set interest rates based mainly on a borrower’s creditworthiness. That means they look at your credit score and credit history to determine if you are a lending risk.
You can still qualify for a personal loan if you have bad credit, but options may be limited, and you may end up with a higher interest rate.
Knowing your credit score and history can help you determine what kind of loan you may qualify for and the rates you could receive.
It also allows you to look for errors or negative marks negatively affecting your credit. Then, you can report errors or take action to improve your credit before applying for a loan.
The three major credit reporting bureaus, Experian, TransUnion, and Equifax, recently announced that they will continue to offer free weekly credit reports to American consumers through December 31, 2023.
Free credit reports from all three credit bureaus are available through AnnualCreditReport.com.
You can also access your credit score through several outlets.
Some credit card issuers and banks provide free score access for account holders.
You can also get your credit score for free or a small fee through some credit monitoring companies.
There are several credit score models, including FICO and Vantage scores.
FICO credit scores are the most widely used score model used by lenders.
Pay attention to which score you’re accessing, although all of them will give you a reasonably accurate snapshot of your current credit situation.
Not Considering Other Options
Personal loans provide access to immediate funds when you need them.
They aren’t the only option you should consider, though.
Depending on your need, some alternatives can provide the necessary money, no matter the reason.
Alternatives to personal loans include:
- Balance transfer credit card
- A personal line of credit
- Peer-to-peer loan
- Home equity loan
- Home Equity Line of Credit (HELOC)
- Cash-out mortgage refinance
- Borrow from family or friends
Depending on the timing of your need, you can also set aside money in a separate account.
If you’re planning a once-in-a-lifetime family adventure to Hawaii, for example, you can calculate how much money you need to save and when you need to book travel plans and set aside money each month to fund travel costs.
Compare each option’s benefits and risks to determine the best course of action to fund your financial need.
Choosing a Lender That Charges Prepayment Penalties
No rule says you can’t pay off a personal loan before the end of the repayment term.
However, you may end up paying more to pay off the debt.
Some lenders charge what’s known as a prepayment penalty. This is a fee charged to borrowers for paying off a loan early before the repayment period ends.
Paying off a loan early can help you save significant money.
By paying it off early, you avoid additional interest charges.
If you pay off a loan 12 months early, for example, that’s 12 monthly payments without interest that you don’t have to pay.
For lenders, that’s money they miss out on because of your early repayment. Some, but not all lenders, charge prepayment penalties.
Check with lenders to see if they charge a prepayment penalty before you apply for a loan.
Many quality lenders don’t charge these additional fees, so shop around to find one that doesn’t if you plan on paying your loan off early.
Using a Personal Loan for Basic Expenses
You shouldn’t take out a personal loan unless you have a good reason.
There are plenty of good uses for a personal loan, but using the funds for basic expenses is not one of them.
If your current budget doesn’t cover monthly basic living expenses, taking out a loan only provides a temporary (and short-sided) solution to your financial needs.
You could also create a more significant long-term economic issue by using a personal loan for monthly expenses.
Not only will you have to pay back the loan, but you’ll also have to pay interest on the loan amount.
If you’re struggling to pay living expenses from your income, start examining your spending habits.
Track your spending to see if there are any areas of concern or line items you can cut out, even temporarily, to stretch your money further.
You may also need to increase your hours at work, ask for a raise, or work part-time to improve your situation and escape the debt cycle.
Providing False Information on Your Loan Application
It might be tempting to provide exaggerated information on a loan application to improve your chances of getting approved, but it is considered fraud and is a crime.
Lenders ask for personal and financial information when you apply for a loan.
Lenders often perform due diligence to ensure the information provided is accurate.
Some of the common ways people may lie on loan applications include:
- Income
- Amount of debt
- Employment records
- Residency
- Asset values
- Loan purpose
There are consequences for lying on a loan application.
If discovered, the lender may cancel your loan application.
If you’ve already received loan funds, you may have to pay them back immediately.
You could also face legal action if it’s determined you provided false information to secure a loan.
While jail time is unlikely, it’s always a possibility. You could also have to pay restitution if convicted of fraud.
The best way to avoid potential fraud accusations is to provide the most accurate information possible when you apply for a loan.
Gather the proper documentation to speed up the process and ensure that every detail on the application is correct.
Frequently Asked Questions
What credit score do you need for a personal loan?
Credit score requirements vary between lenders.
There are personal loans for individuals with poor to excellent credit.
Generally, the better your credit score, the more likely you will qualify for a loan and lower interest rates.
How can I qualify for a personal loan?
Lenders look at several factors when determining eligibility for a personal loan.
Credit history and credit score play a significant role in determining whether a borrower is eligible.
Some lenders also look at income, employment history, assets, debt-to-income ratios, and other factors to gauge the riskiness of lending to an individual.
How much can I borrow with a personal loan?
Personal loan amounts can range from $1,000 to $50,000 with many lenders.
Some lenders offer personal loans for up to $100,000 in some cases. Lenders may set minimum loan amount requirements.
