Personal loans are available to finance a home renovation project, pay for a funeral or consolidate credit card debt. After the 2008 financial crisis, the loan product gained popularity and is one of the fastest-growing for banks.
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They are not for everyone. This is especially true as lenders and banks raise lending standards
Personal loans are usually unsecured. This means that they don’t require collateral such as a house, bank account or other assets to provide leverage for the bank. Personal loans allow you to borrow a set amount and then repay it over a time frame at a fixed interest rate. Although this may seem simple, there are many details involved in taking out a personal loan. For example, you need to check what fees will be added to the loan and make sure your credit report is clean.
These are the top do’s and don’ts when applying for a personal loan.
- Do you need a personal loan?
- Do: Examine your credit reports
Personal loans will have a lower interest rate if you have a good credit rating and a strong credit history. Credit is a barometer of risk for banks. You are more likely than others to repay your loan if you have paid your loans on time. The lower your rate, the better your credit score. Rates will generally range from 4 to 36%.
Due to the COVID-19 pandemic, the three major credit bureaus (Equifax, Experian, and TransUnion) are offering free weekly reports at AnnualCreditReport.com through April 2021. We recommend that you check your credit reports regularly to ensure they are in good shape. A mistake (e.g. missed payments or fraudulently attached credit cards to your name) could cause credit scores to plummet.
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- Do: Compare the APR
It can be significant to see the difference between a lower interest rate and one with a higher interest. Let’s take an example: a $10,000 loan with 5-year terms. The difference between a 10% and 25% APR over five years would be $4862.56. Because each lender weighs your application differently, we recommend that you shop around before making a commitment to one.
- Do not ignore the potential risks of having bad credit.
A personal loan with an interest rate of at least 5% may not be possible if your credit score is less than 670 (good) according to FICO standards. A loan may not be available to those who have never established credit or filed for bankruptcy.
To increase their chances of approval, people who are in this situation may want to have a cosigner. Cosigners are secondary borrower that can help you get approved for a loan by proving their credit history. The bank can rely on a cosigner to ensure that the loan is not defaulted.
A cosigner can help you get a better rate and grease the wheels of an offer. The downside is that if you fail to make a payment, your credit score and the cosigner could be affected.
- Do: Pay attention to the fees
Before you accept a loan offer, make sure to go through it with a fine tooth comb. It is important to ensure you fully understand the contract before you sign it. Otherwise, you could be subject to unexpected fees. These are the most important parts of a personal loan that you need to understand:
What is the APR? Is it fixed, variable or constant? Is it lower than your credit card’s rate? A loan might not be worth the cost if it is not.
- Repayment Period: How long are you going to make your monthly payments and when will the loan be due?
- Monthly payments: Are you able to afford them? Are they within your budget?
- Secured or unsecure: Do you need to collateralize the loan with your bank account? Is collateral not required?
Origination fee: Is there an upfront fee for the loan? If so, how much is it? Are they being honest? Remember that lenders who don’t charge this fee may still charge it. This fee is reflected in the interest rate.
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Prepayment penalty: If you pay the loan off early, will you be charged a penalty?
- Do: Get prequalified by multiple lenders
Pre-qualification allows you to self-report your financial information, as well as the terms you desire. This will give you an estimate of how much personal loan you might be eligible for. This is different than applying for a loan or getting pre-approved. The lender doesn’t have to review your documents, and there won’t be a hard credit inquiry which could lower your credit score. Pre-qualification does not mean that you will be approved. It just lets you know if you are likely to be approved, and what the terms of your loan might be. Personal Loans Don’t
- Do not accept the first loan that is offered to you
Before you commit to a loan, always shop around. Personal loans are not only available from the big banks. These loans can be found at community banks, credit unions, online banks and online lenders. Many of these institutions could offer a better rate that your mega-bank.
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Lenders evaluate different applications. Credit and income are weighted differently depending upon the criteria. One bank may not like the fact that you have been laid off, but another bank might be happy to lend you money because of your “excellent” credit record. You can’t control everything so expand your options.