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Maybe you’re arranging a long-delayed honeymoon in Hawaii. Perhaps you’re itching to consolidate thousands of dollars in credit card debt. Whatever the occasion, a personal loan can help cover planned or unexpected expenses.
However, getting a personal loan involves much more than filling out an application and then spending the cash. You need to do your homework to ensure you’re getting the best deal possible. And you also need to consider whether a personal loan is really right for you.
What is a personal loan?
Before we get started, let’s be clear about what a personal loan is. Unlike a credit card, which lets you gradually borrow money, a personal loan gives you one amount of money — $10,000, for example — all at one time.
Also, a personal loan is unsecured debt, meaning there’s no collateral that a lender can seize if you fail to keep up with the payments. That’s in contrast to a home loan or an auto loan, with a residence or car serving as collateral that a lender can take if you fall too far behind on payments.
Here are six things you should do before getting a personal loan:
1. Figure out whether you should get a loan
Be honest with yourself: Do you need a personal loan? Can you afford it?
If you answer “no” to those two questions, then you probably aren’t in the best position to take out a personal loan. A trustworthy lender can tell you when a personal loan isn’t the right move for you, says Joe Toms, president of the Freedom Financial Asset Management business at Freedom Financial Network.
“If a borrower is struggling to make minimum payments on current debt, a personal loan will usually not help,” he says.
In that scenario, debt consolidation might be a smarter option.
Toms says that if you do go ahead with a personal loan, borrow only what you need and what you can repay on schedule. Also, he says, remember that a longer-term loan with smaller monthly payments will end up costing more than a shorter-term loan with bigger monthly payments, since the shorter-term loan will result in lower interest charges.
“Think about the initial cost of the loan and compare it with what you hope to accomplish as a result of borrowing. Consider other ways to achieve your goal by borrowing differently or not borrowing at all,” says Bruce McClary, vice president of communications at the National Foundation for Credit Counseling.
2. Check your credit scores
Once you’ve decided a personal loan is right for you, the next step is to check your credit score. If you have a credit history, you’ve got a credit score — actually, you’ve got several credit scores.
Before you shop for a personal loan, be sure to check your scores. The higher the scores, the better your chances are for loan approval and the lower your interest rate will be. Generally speaking, a credit score of 700 to 850 is considered good; anything below that isn’t so good.
“A wide range of credit scores can qualify for a personal loan; every lender and every individual is unique,” Toms says.
Many credit card issuers and personal finance websites provide free credit scores. Checking your credit score won’t harm your credit.
3. Check your credit reports
While you’re checking your credit score, you also should take a look at your credit reports. Each of the three credit-reporting bureaus (Equifax, Experian and TransUnion) produces a credit report based on your credit history, such as whether you’ve paid bills on time.
If you spot a mistake on a credit report — for instance, a bankruptcy is listed when you’ve never filed for bankruptcy — you should contact the issuer of the report to fix the error before you apply for a personal loan. Just one error on a credit report can cause you to pay a higher interest rate or to even have your application rejected.
Once a year, you can obtain a free credit report from each of the three credit bureaus at AnnualCreditReport.com. Pulling your credit reports won’t hurt your credit.
4. Shop around
Don’t go with the first loan offer you see without weighing all your options. It’s best to consider several lenders before submitting an application. Do some searching online to find out what various lenders are offering, such as:
- The interest rate of the loan. A lower interest rate means that, over time, you’ll pay less for the loan. Of course, as we mentioned before, the higher your credit score, the likelier it is that the interest rate will be lower. The typical interest rate for a personal loan can range from 4 percent to 25 percent, Toms says. In some cases, it might be wiser to charge expenses on a lower-interest credit card than to obtain a higher-interest loan.
- The length of the loan. Toms says most personal loans come with payoff periods of 36 to 60 months, along with strict payment schedules. Before applying, think about whether you can make at least the minimum payment every month. Only one missed payment can trigger a decrease in your credit scores.
- The fees charged by the lender. With a personal loan, you’re typically charged what’s known as an origination fee. That fee usually is 1 percent to 5 percent of the loan amount, Toms says. A reputable lender will be upfront about this fee and explain how it’ll affect the cost of borrowing money.
5. Check out the lender’s reputation
You don’t want to do business with a shady lender. No matter what kind of lender you’re considering — a bank, a credit union, a finance company — look into the lender’s track record.
If a lender’s online reviews are bad and its Better Business Bureau ratings are poor, and if friends, relatives and colleagues have badmouthed that lender, it’s probably best to move on to a more reputable lender.
6. See how helpful a lender is
Toms says some lenders might be more willing to overlook past financial issues in approving a personal loan than other lenders are.
“In other words, you’re more than just your credit score,” he says. “Maybe you’ve planned and saved for retirement, or maybe you can have another person sign on the loan as a co-applicant to show the lender your efforts to be a good borrower.”
On top of that, you might be able to score a discount on the interest rate of your loan if you pick your existing bank as a lender.
In the alternative, you might get a break on the interest rate if you open a checking or savings account with a new lender you’ve never done business with, says Andrew Levin, senior vice president of consumer unsecured lending at Citizens Bank. And regardless of which lender you go with, setting up automatic payments for your loan can trim the cost of the loan, he says.