If you need some extra flexibility with your finances in 2023, a personal loan might be a good option. Personal loans can be used for almost any purpose, from renovating your home to consolidating your debt to making a major purchase. But personal loans are tools that need to be managed. Without asking the right questions, you might end up with a loan that doesn’t properly suit your needs or your personal financial situation, which could lead to financial problems down the road. Here are some of the most important do’s and don’ts when it comes to personal loan shopping in 2023.
Do: Shop Around for Rates
Although personal loan rates tend to cluster around certain levels, the truth is that loans can be all over the map. A multitude of factors, from the term you choose to your credit score to the amount you borrow to the characteristics of the individual issuers can alter your rate. And even if you think the rate you’re offered isn’t “that much” higher than a competing rate, the amount of interest you pay can add up dramatically over time.
Take this simple example as an indication of how important your interest rate is. Imagine you are borrowing $20,000 for 10 years, and the two interest rates you are offered are 7% and 8.25%. You might think “oh, that’s only a 1.25% rate difference,” but here’s the real difference in black and white. The 7% loan will cost you $7,866.04 in total interest, with a monthly payment of $232.22. [1] Now, the 8.25% loan will only bump up that monthly payment to $245.31. However, the total interest you pay will rocket up to $9,436.63, a jump of 20%. [2] This shows how relatively small jumps in your interest rate can cost you significantly over the long run.
Don’t: Always Take the Loan With the Lowest Rate
Although your interest rate is a critical factor when it comes to choosing your personal loan, it’s not the only single factor you should consider. The reputation of the lender, the quality of its customer services, the speed and ease of its funding process and the term options it offers should all play a role also. For example, if you find a loan for 7.5% that doesn’t allow prepayments, it might be better to take the 7.75% option that lets you refinance with no penalty in the future if rates fall.
Do: Calculate the Loan Amount You Really Need
Personal loans may feel like “free money,” but you’re committing to making regular payments for years on that loan, and you’ll be paying back more than you initially borrowed. A personal loan should only be taken in the amount that you need, whether it’s the amount of the outstanding debt you need to consolidate or the dollar amount that you’ll need to pay your contractor to renovate your house.
Don’t: Take the Maximum Loan Amount You’re Offered
If you apply for a loan without doing some preparation first, it can be easy to be sucked in by the high maximums that many companies offer. For example, you might only need to borrow $20,000, but if you apply for a loan and the lender offers you $40,000, you might be tempted to use that. The problem is that when you borrow more than you need, you end up paying additional interest on funds you’re not even going to use – or even worse, you’ll be tempted to spend that extra money on discretionary items. Either way, you may find yourself in a bigger financial hole than you can crawl out of if you borrow more money than you need.
Do: Check for Eligibility Requirements Before You Apply
This is a bit of a no-brainer, but you should always check the eligibility requirements of a particular lender before you apply for a loan. Some lenders will only approve borrowers with credit scores above a certain level, for example, while others might only approve those that are members of the military or a particular credit union. In short, don’t assume that all lenders are the same. Do your homework before you apply to make the whole process run more smoothly.
Don’t: Apply With a Lender Because You Assume You Will Get Approved
When you apply for a personal loan, your potential lenders will run a credit check that will appear on your credit report for two years. This is true whether you are approved for a loan or not. While credit inquiries will not tank your credit score, they will typically drop it by a few points. This can potentially make it more difficult to get additional loans while those inquiries remain on your report. This shouldn’t dissuade you from applying for a loan, but it does mean you should only try to get loans that you feel you are qualified to get.
Do: Consider Additional Features and Benefits
In addition to offering straight loans, some lenders provide additional features and benefits to entice long-term customers. For example, if you take out a personal loan with a particular bank, you might be eligible for a no-fee credit card, a free checking account or a discount on additional loans you take out, such as a home mortgage. If you’re in the position where these additional perks provide a benefit to your financial life, they’re worth considering as part of your loan package.
Don’t: Pay Too Much for Ancillary Perks
While ancillary perks are a plus, if they cost more than they are worth, then you’re not doing yourself any favors. In fact, offers that you don’t need can potentially end up getting you in a deeper financial hole. For example, if you don’t need a new credit card, taking one just because it’s “free” could lead to overspending. Similarly, if you’re enticed to buy a home you can’t afford because you’re getting a 0.25% rate discount, that could end up being a financial disaster. You should always focus on your primary goal first – in this case, your personal loan – and only then factor in added features or benefits.
About the Author
David Halverson
With over 10 years of direct experience in the lending space, Lendzi’s leaders have established over 60 partnerships with top lending institutions and have overseen an excess of $500 million raised for entrepreneurs across America.