Are you considering applying for a personal loan?
A personal loan doesn’t have the tight restrictions other kinds of loans do. It’s not tied to your mortgage or car. It’s not the kind of loan you can pay off in a week, either, like a payday loan.
Maybe you’re in a pinch and need some extra money for that leaky roof, or you’re feeling adventurous and want to go on a lavish vacation; there’s no shame in taking out a loan. Maybe you’re the owner of a Michigan business and want to expand to Indiana or Ohio and need that extra money to help your business expand.
Is taking out a loan like this right for you? To find out, there are several questions you need to ask yourself first. Cross these out to determine whether you should apply for one today:
1. Is a Personal Loan My Only Option?
Yes, getting a loan has a lot of nice perks and benefits. The interest rate is often not that high, especially when compared to some credit cards. You don’t have to pay everything back at once, and it’s a low-risk financial move that most people with a job can afford.
However, you have to ask if getting that loan is your only option. At the end of the day, you still have to pay it back, and there will be fees and interest rates to deal with. If you can buy or pay what you need without the risk of a loan, consider that option first.
Before taking out a personal loan, consider selling or pawning something. Can your savings cover what you want to spend on? Is there a cheaper loan option or financial gift you can wait for?
When there’s no other option, dive into taking a personal loan. That said, not every loan is the same. Follow up this question with the next ones on this list.
2. How Much Should I Borrow?
Decided to take out a personal loan? Great, but now you need to decide how much you’ll borrow. The amount you decide on will have multiple repercussions to consider.
The amount you borrow and the attempts you make to take out a loan can and will affect your credit score. It’s always better to spread out your loans within a year, ensuring that your final score doesn’t take a sudden plunge.
Keep in mind that the amount you borrow directly affects how much you’ll pay back and for how long. Bigger amounts require bigger monthly payments, different interest rates, and longer terms.
Don’t borrow more than you need. If you only need $10,000 to pay the downpayment of a car or for a party expense, stick with that amount. Don’t borrow more because there is always the temptation, the risk, that you’ll use the extra cash on something you don’t need.
You’ll end up paying for an unnecessary expense. Keep it simple and stick with your budget.
3. How Much is the Payment?
Your biggest concerns are the loan payments. How much is the interest fee added on top of your loan, and how much will you pay each month?
Your loan payments will affect your monthly budget the most. This is why you shouldn’t shy away from asking the lender this question before signing anything.
How do you know the payment term is within your reach? The first step is to compute the average amount you earn per month within a year. Next, take a look at your bank records for the past six months and get an average of your monthly expenses.
This list of expenses should include your bills, groceries, and personal expenditure. Check how much remains per month. This is going to be your budget for monthly loan payments.
If the loan payment per month is higher than your budget, it’s not a viable option. You might end up using your credit cards or consider taking another loan to pay off the first one.
4. How Long is the Payment Term?
Found out your loan expenses per month? Don’t stop there. You need to also ask about the payment term.
After all, you don’t want to keep paying for a personal loan for too long. The longer the loan term is, the longer you won’t be able to take out another loan without affecting your credit score. Taking out another loan while the first one is still ongoing could also seriously damage your budget.
The amount you borrow will also affect how long you’ll pay it back. You could potentially pay off a $10,000 loan in a few weeks or months, but a bigger loan, like $100,000, could take years to pay. Are you prepared for a long-term financial commitment like that?
Remember that you can adjust loan terms too. You could pay a $10,000 loan with a 10% interest in only six months. This means you’d pay approximately $1833 per month, amounting to $11,000 total.
What if you could pay it back in two years instead, but with a 14% interest fee? This would alter your monthly payments to $475 a month. That’s a much lower monthly payment, but the total now amounts to $11,400.
5. Can I Pay It Back?
Always ask if you can pay the loan back. Consider how long the loan term is and the budget needed each month to pay on time. Make sure to check if you have any savings in the bank too.
Never underestimate how random life can get. You could skim through the months and pay the loan back but only while you’re still employed. What’s your backup plan in case you suddenly lose your job?
The ongoing pandemic continues to affect employment rates, after all. You could perform well at work, but if the business itself crumbles, you might end up without a source of income to pay off the loan you took.
When things get ugly, ask about repayment flexibility. This refers to the option to alter your payment terms. You’ll need this in case you need to lower the monthly payments, but this will increase the loan term, meaning you’ll pay for a few months longer.
6. What Are the Fees?
When taking out a personal loan, the interest rate isn’t the only fee you’ll have to factor in. There are some other fees to pay, too, such as a processing fee and application fee.
An application fee is exactly as it sounds: a small fee to apply for a loan. This is even before you get approval. It can sound disheartening to pay before you even know whether or not you’ll qualify for a loan, but it’s often not too costly.
The processing fee comes after approval. They need to process the loan, which requires paperwork, audits, employee labor, and more. This fee will cover the bank’s expenses to get your loan out the door.
Of course, there is also a fee for late payments. This could come in the form of an increased interest rate or separate monthly fees until you get the payments back on track. Never forget to ask about late payments and penalty fees to avoid any surprises upon seeing your bill.
7. How’s My Credit Score?
Don’t forget that a personalized loan can and will affect your FICO score.
A FICO score ranges from 350 to 850. The better your FICO score, the better your chances are of qualifying for a loan or credit card. This is because your score is a good indication that you know how to pay back your debts.
In a nutshell, your FICO score is an indication of financial responsibility.
Your FICO score changes every time you apply for a loan, make a payment, miss a payment, or qualify for a loan. This is because each of these actions gives clues regarding the way you manage money. If you have to take out multiple loans, for example, you become a financial risk, and this lowers your FICO score.
FICO scores also affect the rates and terms of a personal loan. A high FICO score could guarantee you a lower interest rate and a longer payment term. A lower score could disqualify you for a loan or grant you one with a high interest fee.
8. Is This the Right Lender?
When everything looks right, the final question to ask is about the lender. Make sure you approach the right lender, one who won’t swindle you with confusing jargon and hidden fees. Read reviews and always read the fine print before signing anything.
Sometimes, a bank isn’t even the best option. For example, you could qualify for a personal loan by Plenti to avoid high annual fees. Banks can also take too long to audit your account, and there’s no guarantee you’ll qualify.
Consider These Factors When Taking Out a Loan
Make sure to go back to this guide and ask these questions before signing up for a personal loan. Taking out a loan can be a good option for people who can afford to pay it back. It’s not a financial option for those already deep in debt.
Of course, a personal loan isn’t the only financial option out there.
For more financial guides or if you want to read tips about fitness and health, family, and more, we recommend reading more of our posts. Our lists cover a wide variety of topics, so feel free to keep discovering great advice right here!