Need a Personal Loan? 9 Questions To Ask Before You Apply
Things to consider before getting a personal loan
Personal loans offer a cost-effective way to borrow for significant expenses compared to credit cards. In the US, approximately 23.2 million borrowers owed $241 billion in personal loans by the third quarter of 2023, double the amount from 2017. While less than other debts like mortgages and credit cards, the growth is notable. Having a repayment plan is crucial when considering a personal loan, whether for consolidating debt, home improvements, or moving expenses. Here are 10 essential questions to help borrowers prepare for obtaining a personal loan and managing repayment effectively.
1. How much amount do I need?
The smallest personal loans generally start at approximately $500, although most lenders set a minimum threshold ranging from $1,000 to $2,000. Should the need for funds be less than $500, it might prove more convenient to accrue savings, utilize a credit card, or seek assistance from family or friends.
2. Do I want to have the money sent to my bank account?
When you apply for a personal loan, the money typically gets deposited into your checking account. But if you're using the loan to consolidate debt, some lenders may send the funds directly to your creditors. If you like to manage the funds yourself or plan to use the money for purposes other than paying off debt, you can have the funds wired to your checking account.
3. How long will I have to pay it back?
After obtaining the loan, you'll start paying it back through monthly instalments within 30 days. Lenders typically extend repayment terms spanning from six months to seven years, offering flexibility based on your needs. It's essential to consider the length of the loan carefully, as it impacts both the interest rate and the amount you'll pay monthly. Opting for a shorter repayment period may result in higher monthly payments but lower overall interest costs, while a longer term may offer lower monthly payments but higher total interest over time. Selecting the right repayment term aligns with your financial objectives and capabilities.
4. How much interest will I pay?
Your interest rate is determined by various factors, such as the loan amount, your credit score, and the loan term—the duration over which you'll repay the loan. Interest rates typically range from as low as 5.99% to over 29.99%. Generally, borrowers with good or excellent credit scores who opt for shorter repayment terms qualify for the lowest interest rates. Based on the most recent data from the Federal Reserve, the average APR for 24-month personal loans stands at 12.17%. This rate is often considerably lower than the average APR for credit cards, prompting many individuals to use loans for refinancing credit card debt. Personal loan APRs are commonly fixed, meaning they remain unchanged throughout the loan's duration.When applying for a personal loan, you have the flexibility to choose a repayment plan that suits your income and cash flow. Some lenders offer incentives, like a reduced APR of 0.25% to 0.50%, for setting up autopay.
5. Can I afford the monthly payments?
Certain borrowers prefer stretching their payments over a longer period to keep monthly payments low, while others prioritize paying off the loan quickly by opting for higher monthly payments. However, selecting a low monthly payment with a long repayment term often results in a higher interest rate, leading to higher overall loan costs over time.As a guideline, aim to allocate no more than 35% to 43% of your income towards debt, including mortgage, car loans, and personal loan payments. Mortgage lenders typically decline loans for those exceeding a 43% debt-to-income ratio, while personal loan lenders may be more lenient, especially for applicants with good credit and stable income. Although it's possible to temporarily stretch your budget for higher payments to save on interest, it's crucial to avoid overextending yourself financially. A debt-to-income ratio above 40% may hinder loan approval and could lead to cash flow difficulties. Only consider this approach if you have a backup plan, such as a partner's income or emergency savings.
6. What fees do I have to pay?
The majority of lenders typically only apply interest charges, but some might impose an origination fee—a one-time upfront cost deducted from your loan amount to cover administrative and processing expenses. This fee typically ranges from 1% to 5% of the loan amount, occasionally as a flat fee. For instance, if you borrowed $10,000 with a 5% origination fee, you would receive $9,500, while the remaining $500 would go to the lender. Origination fees are infrequent enough that you can usually sidestep them with careful selection of lenders.
7. Is my Credit Score good enough?
Before applying for personal loans, knowing your credit score is essential. Most lenders, especially online banks, prefer a credit score of 690 or above. However, if you have a good history with your bank, you might still get approved with a lower score. Some credit unions offer lower rates but require membership and possibly a savings account. Upstart caters to those with limited credit history or no score, but expect higher fees and rates. Always review terms before agreeing to a loan.
8. Do I have any other options?
If you're aiming to pay off debt, consider a balance transfer credit card with a 0% introductory APR as an alternative to a personal loan. These cards enable you to avoid interest payments, with some offering up to 21 months of zero interest, potentially saving you hundreds of dollars. In addition to facilitating balance transfers, 0% APR credit cards are ideal for financing substantial purchases over an extended period.
9. Will taking a personal loan affect my credit score?
Although taking out an installment loan won't directly increase your credit score, using a personal loan to pay off revolving debt can lead to a significant improvement. After paying off your cards, aim to keep your spending below 10% of your available credit, and you'll likely notice a positive impact on your score.