7 Personal Loan Mistakes And How To Avoid Them

Personal loans are a versatile option to cover big expenses, but they aren’t without risks. You could damage your financial health if you borrow more than you can comfortably afford to repay or settle for a loan with unfavorable terms. You also risk incurring excessive fees or damaging your credit score if the loan isn’t managed properly.

The upside is that understanding these risks and reading the fine print before applying will help you avoid making these costly personal loan mistakes.

1. Taking out a longer or larger loan than necessary

While long loan terms result in lower payments, a shorter term or smaller loan amount means less interest paid to the lender — which means you save money.

A longer loan term means a lower monthly payment and a lower payment sounds good. But there’s a catch: A longer term means that the lender will have more time to collect interest from you, which means the loan will cost more overall than it would if you’d selected a shorter term.

Let’s say you need to borrow $20,000, and you qualify for a 12 percent interest rate. Here’s what the loan would cost across several repayment terms:

While the three-year repayment term has a high monthly payment, you’ll save a whopping $5,743 in interest over the life of the loan. Select the shortest repayment term you can realistically afford.

It can also be tempting to take out a larger loan than you truly need, just to have a little extra cash on hand. But the larger the loan, the higher your payment will be and the more interest you’ll pay overall.

Use a loan calculator to determine whether your payment fits your budget. You may have to borrow less or consider a different loan term, but your wallet will thank you.

2. Not shopping around for the best offers

Many lenders have prequalification processes so you can quickly compare rates without harming your credit. Even if you’re crunched for time, you can still find the best offer.

If you desperately need cash, it could be tempting to go with the first lender you find that approves your loan request. Unfortunately, this could be a costly mistake. With only one offer in-hand, there’s no way to know whether you’re getting the best deal or if there are better options.

For example, here’s what you’ll pay for a 36-month, $15,000 loan with different interest rates.

If you had taken the first loan offer, you’d be leaving money on the table — the second loan option would save you $1,014 in interest over the first loan, and $1,797 over the costly third option.

Prequalification lets you explore multiple loan options from banks, credit unions and online lenders without impacting your credit score. You can use a loan matching tool to view potential offers in minutes. Marketplaces like LendingClub allow you to compare rates side-by-side. Try to compare at least three lenders.

3. Not considering your credit score

Most lenders have minimum credit score requirements. If you don’t meet these, it is better to wait before applying and focus on improving your score first.

Lenders want to know that you can afford to repay what you borrow, which is why most require you to provide employment and income information. Lenders also review your credit score and credit history to see how responsibly you’ve managed loans in the past.

The best personal loan interest rates — near or below the national average of 12 percent — generally go to applicants with good or excellent credit scores. These are typical APRs for each credit score range, according to TransUnion’s first-quarter report on the personal lending industry.

Bad-credit interest rates can be around three times higher. Bad-credit borrowers often end up spending several hundred or thousands more in interest than those with good credit borrowing the same amount. The lender might also deny your application if your credit score isn’t up to snuff.

You should check your credit before applying for a personal loan to avoid any surprises. If your credit score is on the lower end, it’s worthwhile to explore other options to get the cash you need. In the meantime, review your credit report and file disputes if you notice inaccurate or outdated information that could be dragging your credit score down.

Bankrate tip

Many lenders have a minimum FICO credit score around 660, though bad-credit lenders may go as low as 580 and some have requirements of over 700.

4. Overlooking fees and penalties

Not every lender charges fees, but many impose an origination fee and late fees. When you research lenders, consider how much it will cost you to borrow beyond the interest rate offered.

Some loans come with fees that could be costly if overlooked, including:

• Origination fees are the processing fees assessed by the lender to set up the loan and typically range from 1 to 12 percent of the loan amount. The origination fee is typically deducted from your borrowed funds before you receive them, so you may need to borrow extra money to account for the fee.
• Late payment fees are standard if you miss the due date or submit your payment after the grace period. Late payment fees commonly run around $39.
• Returned check fees are the penalties you’ll be charged if your payment can’t be processed because you have insufficient funds in your account. Returned check fees also tend to be around $39.
• Application fees are charged for the privilege of applying for a loan. Reputable personal loan lenders don’t typically charge an application fee.
• Prepayment penalties are the fees the lender charges if you pay the loan off early. These are also rare among reputable lenders.

You can avoid late and returned check fees if you make timely, full payments. While it’s very possible to find lenders that don’t charge origination fees, a small origination fee on a loan with a low APR may wind up being more affordable than a no-fee loan with a high APR. Crunch the numbers on any loan offer before signing the loan agreement.

5. Not reading the fine print

You should review the fine print of everything you sign and ask the lender any questions. Otherwise, you could violate the terms of your loan or be surprised by the lender processing automatic payments without your knowledge.

Before they finalize the loan, the lender will send closing documents electronically or hand them to you for review. The fine print includes information about interest calculation, acceptable payment methods, due dates and the fee schedule. It will also mention whether the lender charges more for certain types of payments or automatically withdraws payments.

You must agree to the terms and conditions and sign the documents before the loan proceeds are sent to you. Depending on the lender, there may be several pages to review and sign to close the loan. But if you sign without reading, you risk incurring unnecessary fees and penalties.

6. Lying on your loan application

Avoid providing false information when you apply for a personal loan. Otherwise, you could face serious financial and legal consequences.

Review your loan application in its entirety before submitting to confirm the contents are accurate and can be substantiated with documentation. It may be tempting to overstate figures or omit information to secure the funding you need, but your actions could backfire.

If the lender finds out that you falsified your application, they could cancel your loan or demand repayment for the total amount owed immediately. There are also more severe outcomes, like lawsuits that result in legal fees and monetary penalties. And in extreme cases tied to identity theft and other serious criminal offenses, you could be arrested and sentenced to jail time.

7. Falling behind on payments

Prioritize making on-time payments every time to avoid late fees and a hit to your credit.

If you’re more than 30 days late, your lender will consider your loan in default and report your delinquency to the credit bureaus. This will show up on your credit report for future potential lenders, landlords and insurance companies to see.

Payment history is the largest factor in your credit score, accounting for 35 percent of your score. A late payment can stay on your credit report for up to seven years. How much a late payment affects your score can depend on how late the payment is and how low your score was to start.

Most lenders also assess late payment penalties that can add up quickly. But you can avoid these costly fees and protect your credit by enrolling in autopay or using bill pay if it’s offered by your financial institution.

Bottom line

If you decide a personal loan is necessary, consider your budget and shop around to find the best deal. Finding a loan with a competitive interest rate and affordable monthly payments at a reasonable loan term will help you avoid spending money you don’t have to.