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Personal loans are versatile financial tools. Borrowers can use them to consolidate and refinance debt, make major purchases, or cover gaps in their emergency fund when unexpected events happen. However, planning for the loan and using it properly is important. This entails knowing what to do when looking for and using personal loans, along with what to avoid. This article explores several things to do and avoid when borrowing and using a personal loan so you can get the most out of yours.
What to do when getting a personal loan
Here are some smart choices to make when getting a personal loan:
Do check your credit score first
Your credit score is one of the most crucial factors for determining your loan approval, rates, terms, and other aspects of the loan. Request your free annual copy of your official score from the three credit bureaus (Equifax, Experian, and TransUnion). You can also monitor your credit with an online monitoring tool, so you’re up to date on your score whenever you apply. Improve your credit score consistently, too. This will help you access the best amounts, rates, and terms.
Do get prequalified
Prequalification involves seeing potential loan offers you will likely qualify for before a formal application and hard credit check (which lowers your credit score slightly). None of these are guaranteed offers. However, they let you estimate your options and find the best potential loan for your needs with a non-damaging soft credit check. This also helps you plan for repayment.
Do compare lenders
Lenders may differ in the loan terms offered for various reasons. Therefore, you should shop around with multiple lenders to see what’s available and find the best lender. Prequalification again comes into play here. Prequalification from several lenders can help you compare the offers in more detail. That said, compare the lenders themselves, too. Some lenders offering slightly worse terms may offer superior customer service or financial hardship plans that could be useful later.
Do budget and plan for repayment
Personal loans can have fixed, predictable monthly payments, called installments. However, you should evaluate the proposed monthly payment and ensure it fits your budget. Look over your current income, expenses, and monthly debt payments. If necessary, find ways to reduce expenses. Alternatively, seeking a longer loan term for the same amount may reduce your monthly payment, making your repayment plan easier, though you will pay more in interest the longer it takes to pay off.
What not to do when getting a personal loan
Here are some potential pitfalls to avoid when looking for a personal loan:
Don’t borrow more than you can repay
Taking out a larger loan than needed will result in a higher monthly payment and more money paid in interest. This could create additional financial stress, depending on your situation. At the very least, it leaves you with fewer monthly funds to save and invest. It could also unnecessarily raise credit utilization, temporarily lowering your score. The key is figuring out exactly how much is needed for the expense you’re borrowing money to cover and adding a small cushion if necessary.
Don’t apply for multiple loans at once
Applying for a loan causes a hard credit check, which damages your score. This damage fades after a while and disappears from your report after two years. However, too many applications within a short period can increase the credit score and lead to denials for loans you may otherwise qualify for. Prequalification is your solution. As mentioned, it lets you approximate what terms you may qualify for before applying.
Don’t ignore fees, penalties, and APR
The monthly payment is crucial to know, but the total cost of the loan goes beyond that. Fees, penalties, and other charges add to the cost. For instance, some lenders may charge prepayment penalties, making you pay extra for paying off the loan early so they can recoup lost interest.
APR is another good metric to look at. It represents the loan’s overall cost — principal, interest, some fees, and other charges. Sometimes, a loan with a slightly higher interest rate may have a lower APR and be worth it to some borrowers.
Don’t miss payments
Missing payments can have several consequences, such as:
- Credit score damage
- Penalty interest rates
- Late fees
- Worse relationship with the lender
A missed payment may be reported to the credit bureaus and stay on your report for years. This will make future approvals more difficult and make it harder to get the best rates. Setting up auto-pay and sticking to your monthly budget helps ensure you always have the funds to make payments and that they’re made on time.
If you have to miss payments, let the lender know as soon as possible. They may have hardship plans that can help protect your credit score or provide another benefit to you and them.
Know the dos and don’ts to find the good loan option
Knowing what to do and not to do can help you get the most out of your personal loan while minimizing potential downsides. Before getting a loan, always check your credit score or report, get prequalified, compare lenders, and budget or plan for repayment. Meanwhile, avoid borrowing more than you need, applying for several loans at once, ignoring fees and penalties, and missing payments. Follow these tips to find a great personal loan that meets your needs and helps you achieve your financial goals.