Avoiding Personal Loan Pitfalls - SavingAdvice.com Blog - Saving Advice Articles
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Avoiding Personal Loan Pitfalls

By , October 20th, 2015 | No Comments

Avoiding Personal Loans
Personal loans represent a versatile financing tool for a vast number of borrowers and their unique needs, and they now seem to be available from a myriad of sources; online lenders, banks, and credit unions each offer different flavors of personal loan solutions for well-qualified individuals. During a low-interest rate environment, borrowing from a financial institution or private lender is a cost-effective method to fund all kinds of purchases, such as a vacation, home appliances, or a wedding, or to consolidate debt which carries a high-interest rate, like some credit cards or other loans. This method of borrowing offers more predictability than available alternatives by providing borrowers with a fixed interest rate, a steady monthly repayment amount, and extended terms to make repayment fit into most budgets.

While personal loans have specific benefits when compared to other lending products, there exist a handful of mistakes that are all-too-common among borrowers. Work to avoid these five pitfalls with personal loans in order to keep your financial picture moving in the right direction.

Considering the Alternatives

Personal loans are not the end of the road when it comes to affordable financing. Alternatives such as credit cards can offer more flexibility in repayment and, initially, a lower cost of borrowing. For example, the interest rate on a personal loan for someone with excellent credit can be as low as 6%; however, for those with less than ideal credit history, personal loan interest rates can soar as high as 36%. If you’re shopping for a method to finance a big purchase or consolidate other debts with a short repayment term (i.e. 12 – 18 months), you may have better luck utilizing a credit card with a 0% interest rate offer for a balance transfer or purchases.

Doing your Research

With the number of lenders offering personal loans rising, you as the consumer benefit from increased competition. However, not all lenders are created equal. A common mistake among borrowers is failing to do the necessary research on the lender of choice. It is important to get detailed information for each lender you consider, including:

  • Financial stability of the company
  • How the loan is funded (crowdsourcing or internally)
  • Customer service reputation
  • Privacy policy

Each of these factors plays a part in your overall experience with the lender you choose. If something does not sit well with you, take the time to shop around for alternatives.

Having an Affordable Repayment Plan

Like other debt products, personal loans have the potential to negatively impact your credit score if you default on repayment (and improve it if you are successful). The lure of securing a large sum of cash upfront can overshadow the reality that your lender expects to be paid back in full, plus interest. To avoid this common pitfall, make sure you understand how the new monthly payment fits into your budget. If you feel as though the new payment may be pushing your cash flow limits, reconsider your terms by extending the repayment timeline or reducing the total amount borrowed.

Adding up the Costs

Lenders are compensated for providing loans, and you as the borrower pay for the convenience of stretching out payment for a big purchase or debt consolidation. However, the interest rate is not the only cost associated with taking on a personal loan. Some lenders also charge an origination fee – an upfront expense that reduces the total amount you receive as a lump sum. For example, a personal loan of $10,000 that carries an origination fee of 3% leaves you with a deposit of $9,700. The lender keeps the $300 as payment for providing the loan, and you pay interest on the full amount.

In addition to interest charges and origination fees, some lenders also impose charges for prepayment. In these instances, paying off your loan in full prior to the end of the term results in an additional fee tacked on to your final loan payment. Similarly, lenders may charge for late payments or other servicing needs. To get the most out of your personal loan, use a lender that is upfront about these charges or avoids these costs altogether.

Ignoring the Details

The biggest mistake personal loan borrowers face is failing to read the fine print. Lenders are required to provide a bevy of details about your loan, including total interest paid, any ancillary fees associated with servicing, mandatory arbitration, and any circumstances under which terms could change. Take the time to read through your loan agreement and understand what you are getting yourself into. If you don’t agree with the stipulations listed in those details, work with your lender to negotiate the terms or find a new lender.

Personal loans can be a great way to finance some of life’s major expenses but only when you fully understand the agreement you enter into with your lender. Make sure to think through your alternatives and shop around to find a lender who fits your needs for repayment, total cost, and terms within the fine print. Know what you can afford before searching for a new personal loan, and set yourself up for financial success from the start.

Photo: Chris Potter

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