Personal loans are loans issued by banks, private lenders, and credit unions. Some of the more popular uses of personal loans are to consolidate credit card debt, pay for major home improvements or repairs, and other items like vacations. Before you sign on the dotted line there are some questions you should ask to ensure a personal loan is the right solution for your situation.
How do I know which personal loan is right for me?
Before making any decision regarding a personal loan, you should carefully consider all of your options. There are many resources available online, such as financial calculators, that can help borrowers simulate the impact of taking out a personal loan would have on their finances. Using a debt consolidation or personal loan financial calculator, can provide potential borrowers answers to key questions like what would the estimated payment will be based on various personal factors such as your current credit score and loan length? By running the numbers ahead of time, potential borrowers can see which loan package best fits within their budget.
What will lenders want to know about me?
Financial institutions will want to verify that you have a stable income stream and are a good credit risk. Lenders will look at any debt you have, including any outstanding student loans or personal credit card and mortgage debt to determine 1) how much additional debt you qualify for and 2) if you will be able to afford the additional monthly payment on the requested loan. Your credit score indicates how responsible you are with current and past debt and is a major factor in determining the interest rate and terms of your loan. If you have too much personal debt and few assets to provide as collateral to the bank, you may need to have someone co-sign the loan.
What is the approval process?
The approval process for a personal loan is fairly straightforward. Applying for credit will impact your credit score so you want to compare. Once the application is completed, either online or at the financial institution if you prefer, you will receive a pre-approval notice or denial within 1-2 business days. Depending on your lender they may require copies of your most recent pay stubs, W-2’s, and tax returns.
Are there any traps I should avoid?
A personal loan can be a great option to make a major purchase or pay off higher interest debt however, there are several potential traps you should watch out for.
One of the easiest traps to fall into is taking out a larger loan amount than you need. Another trap to avoid is selecting a loan based solely on the interest rate and not the total cost of the loan. The annual percentage rate or APR, is the total cost of the loan including interest and fees expressed as a yearly rate. In an effort to protect consumers in dealings with creditors and lenders, the Truth in Lending Act or (TILA) was passed in 1968. In a series of regulations, the Federal Reserve spelled out in detail what information lenders are required to provide to potential borrowers before they can sign loan documents. The most important information lenders must disclose to borrowers are the annual percentage rate (APR), total cost including fees to the borrower, and the term of the loan.
Prepayment penalties or origination fees are uncommon on most personal loans but are something you want to ask your lender about and verify before signing your loan documents. An origination fee is a fee that is charged upfront and taken out of the loan proceeds. Pre-computing is a method of calculating the interest due on a loan and adding that to the balance due on the loan up front. This has the effect of increasing the amount of interest you will pay if you pay the loan off before the payoff date.
By asking questions and carefully weighing the options before applying for a personal loan, you can avoid costly mistakes and ensure you are making the right decision for your financial situation.