Personal loans can be used for almost anything, from consolidating debt or financing an unexpected emergency to making a large purchase. But there are a few common mistakes to watch out for so your loan doesn't set you back financially or hurt your credit. Here are six blunders to avoid when taking out a personal loan.
1. Not Checking Your Credit First
Lenders use your credit score and the information in your credit report when determining whether you'll qualify for a personal loan and what interest rate and terms to offer you. Checking your report can help you better understand where your credit stands and alert you to any inaccurate information that you may want to take care of before you apply.
If you find your credit needs work, take steps to improve your credit score before you apply so you're not spending more in interest than necessary. You can start by paying down credit card balances and bringing any past-due accounts current. You might also consider signing up for Experian Boost®ø, which lets you add on-time payments for utilities, streaming services, cellphone and eligible rent payments to your credit report to potentially boost your credit score.
2. Not Getting Prequalified
When you prequalify for a personal loan, you get a snapshot of how likely you are to be approved and with what terms. Prequalifying can also help you ensure the monthly payments will fit into your budget before you commit to the loan. The best part is that prequalifying typically doesn't affect your credit.
That's because lenders will check your credit with a soft inquiry, which doesn't impact credit scores. Although prequalifying won't guarantee you'll be eligible for a loan, it does give you the opportunity to compare lenders, rates and terms to find the best deal for you.
3. Not Shopping Around for a Loan
It's common to think that one lender is the same as the next, but that's not always true. In fact, whether you have excellent or not-so-good credit, the interest rate and terms offered by lenders can vary quite a bit. So, accepting the very first offer you receive could mean losing out on hundreds of dollars over the course of the loan term.
Because personal loan annual percentage rates (APRs) can vary widely, consider comparing lenders with a comparison tool such as Experian's free comparison feature to find the right loan based on your credit profile.
4. Taking Out a Larger Loan Than You Need
It's easy to get in over your head by taking out a larger loan than you actually need. After all, the more you borrow, the more you have to pay back, and larger loans may require larger monthly payments. You're also paying interest on your loan, which adds to the total amount you've pledged to repay.
If you can't cover the payments on your personal loan along with all your other ongoing expenses, your debt could snowball out of control. So, if you're taking out a personal loan to consolidate debt but want a bit left over to cover a vacation, you might want to consider building toward your vacation goals by opening a sinking fund using a high-yield savings account instead.
5. Miscalculating Fees and Other Charges
When you take out a personal loan, you typically know your monthly payment based on the APR and repayment period. But underestimating how much a personal loan can cost in hidden fees and other charges can be easily overlooked.
Depending on your creditworthiness, you may be charged an origination fee to prepare your loan documents and check your credit score. Some lenders also charge an application fee. If you miss a payment, you might be charged a late fee, or you could be charged a prepayment penalty for paying off your loan early. Read the fine print on your application documents or ask your lender about fees and other charges so you know upfront what you're getting into.
6. Falling Behind on Payments
Although a personal loan can be useful for many things, it can become a financial headache if you fall behind on payments. You might be on the hook to pay hefty late fees and see a drop in your credit score.
If you lose your job or face an unexpected financial setback and can no longer make your monthly payments, it's important to call your lender right away. Many lenders are willing to work with you to get back on track. Unless you're more than 30 days past due, it is likely your lender won't report your late payments to the credit bureaus, so do your best to get current as soon as possible. To help you stay on track, set up automatic payments to lessen the chance you'll be late again.
The Bottom Line
It's important to manage all types of credit thoughtfully, including personal loans. But mistakes happen, and you can't predict the future. If you forgot to check your credit, took out a larger loan than necessary or fell behind on payments, do what you can now to set things right. To estimate your monthly payments and expected loan payoff date based on your credit, the loan amount and term, consider using a personal loan calculator to help avoid any mistakes before they happen.