According to Experian, the average personal loan balance currently sits at around $16,458 in the USA. After a couple of years of economic uncertainty driven by a global pandemic, it’s no real surprise to see consumer borrowing continue on its upwards trend.
With that said, if you’re looking to take out a personal loan, it’s important that you take some time to strongly consider your options before you sign on the dotted line and commit to any particular loan agreement. After all, most loans are multi-year commitments that can seriously impact your finances, which means that making a mistake when opening an account can burden your financial well-being for quite some time.
On that note, here are five common mistakes that you should try to avoid when applying for a personal loan so you can ensure that you get the best deal on your borrowing.
Applying for too much credit
Frequently applying for credit can be detrimental for several reasons. Firstly, credit is a tool that should be used sparingly (since it comes with a cost). Thus, if you have to rely on a borrowing facility to fund your lifestyle and make purchases, this is a sign that you may be setting yourself up for considerable financial difficulty later down the road.
In light of this, you need to strongly consider whether or not taking out a loan is a prudent decision in your situation. For example, if you have savings or investments, you could cash them in instead of taking on more debt.
Secondly, applying for too many loans and other forms of credit can damage your credit score since these inquiries leave a mark on your file that is visible to other lenders. Multiple searches on your file can in a short period can come across as desperate to lenders, which sometimes insinuates an over-reliance on borrowing.
And finally, applying for too much credit can look irresponsible, which means that there is a higher chance that your loan application will be rejected. If you already have access to money on a credit card somewhere or a large loan or a revolving line of credit, it can raise some red flags to the lender. Be mindful of this.
Not shopping around
According to ValuePenguin, unsecured personal loan rates vary between 5% and 36%. Taking this into account, you should always shop around for the best deal when taking out a personal loan. Finding a loan just a few percentage points lower could mean the difference between paying hundreds and or thousands in interest throughout the duration of the loan. Aside from the rate, there is also a huge difference in terms and conditions that each lender offers, so make sure you find an arrangement that works for you.
Only looking at the monthly payment
Most of the time, lenders will only display the monthly fee that you have to pay over the course of the loan term when you are shopping around. While this helps determine whether or not the loan fits into your budget, it doesn’t paint the full picture of the cost of the borrowing. When taking out a loan, you need to factor all costs into your calculations.
Just because one of your options has a lower monthly payment doesn’t always mean it’s the cheapest. For example, a lower monthly payment over a longer-term could mean that you end up paying considerably more in interest than you would have with a higher monthly payment over a shorter period.
Overstretching your budget
Ensuring your loan payments fit into your budget is one of the most important aspects of applying for credit. Failing to do so means that you could overstretch your budget, which can result in late/missed payments and a wide variety of financial consequences, including:
- Penalties and fees
- Interest build-up
- Derogatory marks on your credit file
Not only will late payments impact your current financial situation, but they will also hinder your ability to take out more credit in the future. In fact, late payments and defaults stay on your credit file for up to ten years, so you should try your level best to avoid them if possible.
The best way to lower the likelihood of making a late payment is through utilizing a personal loan calculator so you can get a better understanding of whether or not a loan option is affordable, given your current financial circumstances.
Not checking your credit report first
Last but not least, it’s worth checking your credit report before you begin applying so you can evaluate your appeal as a borrower. This allows you to better understand how lenders will assess your eligibility and whether or not they will be likely to offer you a loan.
Remember, the better your credit score, the cheaper it will be for you to attain credit since this means that lenders will typically see you as a lower-risk borrower and will offer you a lower interest rate.
Rather than apply for some of the top-tier loans and get rejected (which will negatively impact your credit score), it’s a better idea to check your score first so you can be realistic with your expectations.
Furthermore, it’s not uncommon for inaccuracies to appear in your report. For example, maybe one of your current lenders forgot to note that you have paid your balance, or perhaps there is a late payment notice on your file, but you have always paid your bills on time. Checking your credit file allows you to detect any inaccurate or incomplete information that could be harming your chances of securing the best deal on your loan, so you can request to get them corrected before beginning your search.
Taking out a personal loan can be a tricky process. With the rise of fintech and other alternative lending providers, it can be easy to become overwhelmed with the sheer number of options out there, which can often lead to mistakes. Thus, with that in mind, you should always try to take your time when applying for credit.. Don’t rush into things, and make sure you do your research beforehand.
Above all, your monthly loan payments need to fit in with your current budget since failure to make payments on time can have a negative impact on your credit file, which will make it much harder for you to secure credit in the future and could result in large fines and penalties.