Are you applying for a personal loan? Unless you have a spare few thousand dollars to spend whenever needed, most people will have to use credit or a loan at some point.
Applying for a personal loan can help you pay for big-budget items and emergency expenses. Mishandling a loan can put you in dire financial straits, however.
Some debt holes can ruin your finances for years. Predatory lending can lead to bankruptcy for loans as low as $1,500.
We have 10 tips for avoiding common personal loan application mistakes. Read on to learn all about personal loans so you can safely choose the best loan and avoid debt pitfalls.
1. Not Knowing the Different Types of Loans
If you aren’t familiar with different types of loans and credit, you could end up in a borrowing misfire.
Some loans can only be used for a specific purpose, like auto and home loans. For general purpose loans, common types include:
- Personal loans
- Payday loans
- Title loans
- Pawn loans
Personal loans generally offer lower interest rates to qualified applicants than credit cards. Unlike a home equity loan, you don’t need a house as collateral.
Payday loans are short-term loans with high (three-digit) interest rates and short repayment periods. Your collateral is your paycheck. Title and pawnshop loans are similar, except your car title or expensive items such as jewelry or electronics are the collateral.
These loans are very risky and are even illegal in some U.S. states. Countries like the Netherlands and Australia have strict regulations on payday loan terms to limit predatory lending.
2. Glossing Over Loan Terms and Conditions
Loans are a financial risk to you and the lender. A lender uses different loan terms to mitigate their risks, which affect your own costs and risks.
The loan terms and conditions specify:
- The principal (total loan amount)
- Interest rates
- Finance fees (origination fees, annual fees)
- Repayment period (the time you have to pay off the loan in full)
- Monthly payment amounts
- Missed and late payment penalties
Many terms are based on your credit history and current finances, which determine the lender’s risk assessment.
A low credit score can result in a higher interest rate, for example. Or a high debt-to-income ratio will lower the principal amount for which you can qualify.
Never skip over the loan terms and conditions. A simple fee or term you didn’t understand can make the difference between paying your loan back on time and loan delinquency or default.
3. Choosing the First Personal Loan Provider
Before applying for a loan, compare lenders and their lending terms and conditions.
All lenders are subject to applicable laws and should be transparent about their certifications and licensing. Predatory lenders will have certain red flags.
These warning signs include:
- Unrealistic loan term promises
- Strong-arm sales tactics
- No listed physical address
- No registration, certification, or licensing information
- Unsolicited loan approval (cold-calling, knocking on your door)
- Hiding or avoiding loan terms and conditions
It’s always important to research your lender first.
In addition to lender credibility, you can research and consider available loan terms from different lenders.
Lenders can also negotiate terms like interest rates and repayment periods to a reasonable degree. Personal loan providers can generally negotiate more than banks and credit unions.
4. Falsifying Information on the Loan Application
Predatory lenders will sometimes encourage you to submit fraudulent information during the loan application process to “help” you qualify for a loan. Don’t do it!
Not only is this a red flag for scammy loans, but it’s also illegal. You could face fines and other penalties. Never use false or misrepresentative data on an application. This can include:
- Leaving off debt and recurring expenses like child support
- Overstating your monthly or yearly income
- Lying about current or past employment history
- Falsifying citizenship or residency status
Some penalties can be steep. In the U.S., for example, the penalty for false statements to gain federal loan approval can be as high as $1 million in fines and 30 years in jail.
5. Applying Before Calculating a Budget
Before applying for a loan, you should know exactly how much monthly loan payment is too much.
If your budget can only handle $100 in extra expenses, for example, you need that information before accepting a loan with $150 monthly installment terms.
Many financial advice articles will recommend only a certain percentage of your net income for loans, or a certain formula to divide your monthly income. While helpful for general situations, life isn’t always so exact.
A budget calculator can help you determine your financial wiggle room. Some financial institutions also offer monthly and yearly expense trackers that will accurately show your spending habits and expenses.
The more accurate your budget, the more realistic your loan repayment terms can be.
6. Only Budgeting for Monthly Loan Payments
Repayment installments aren’t the only factor. Added costs like origination fees, annual fees, and application fees can also make or break your budget.
The loan terms and conditions should list every fee, and your lender should give you an accurate overview of all loan costs. Some laws even require lenders to go over all fees with you before signing.
Many borrowers also mistakenly assume their loan is solid because they can afford the monthly loan payments. But if your budget is tight, one missed or late payment can generate fees that create a debt spiral that is difficult to stop.
Always find out every fee and plug it into your budget before signing off on a loan. Your future financial health will thank you.
7. Requesting More Money Than You Need
It can be tempting to take the highest loan amount you qualify for, but you’ll end up paying more in finance costs.
A higher loan amount means more interest over the life of the loan. It can also extend your loan term, compounding extra interest costs. You can determine the difference with a loan calculator.
For example, an $8,000 loan with a 6% APR and a 60-month (five-year) loan term pays a little over $1,200 in interest. A $10,000 loan pays nearly $1,600. A $10,000 loan at 72 months pays over $1,900.
To save money, you should only accept as much principal as you need, with the lowest loan term you can afford.
8. Spending the Loan Before You Have It
Many borrowers mistakenly believe pre-approval is a guaranteed loan. The actual loan application process is different, however, so a pre-approval does not automatically equal loan approval.
Pre-approval uses a soft inquiry vs. hard inquiry into your credit history.
Soft inquiries are a general overview of your credit history. A hard inquiry is a full credit history request from multiple credit reporting agencies.
Qualifying factors that don’t show up on the soft inquiry could scuttle or modify your actual loan application after a hard inquiry. If you spend money on large expenses before your loan is approved, you could end up in financial hardship.
9. Applying For Multiple Loans at Once
You should consider the time between significant loans before applying for a personal loan. If you recently took out an auto loan, home loan, or student loan, a lender may consider you at higher risk for personal loan repayment.
Multiple pre-approvals won’t affect your credit score, but hard inquiries can show up as a negative ding on your credit history. Applying for multiple loans from different lenders can even significantly affect your credit score and increase your lending risk.
Hard inquiries can linger for a few years on your credit history, so use them sparingly.
10. No Back-Up Plan
You can also factor in available options if you experience financial hardship.
Many loans go into default when a borrower has expenses or income loss after the loan’s approval. Find out what options the lender offers in these cases.
For example, personal loan provider Plenti can modify your loan terms during an unexpected job loss or medical illness. Banks and credit unions can also offer hardship programs with options like loan forbearance.
You should also consider early repayment options and penalties. You could end up with extra money like a large tax return, work bonus, or an unexpected inheritance.
If you want to pay off the loan early or pay down a significant amount of principal to lower the total interest, some lenders are more flexible than others.
Some lenders will require a total loan pay-off amount only slightly lower than the full term amount. Other lenders will add fees that negate your potential interest savings.
Smart Borrowers Avoid These Personal Loan Application Mistakes
A personal loan can be necessary during certain times of your life. By avoiding common personal loan application mistakes, you can safely use your loan while avoiding debt holes and defaults.
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