Key Takeaways
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Do not take out a longer or larger personal loan than you need. This way you avoid spending more money on interest than necessary.
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Shopping around for the best deal will ensure you get the best price and lowest cost.
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Consider your credit score when applying for a loan to avoid surprises, high interest rates, or drops.
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Make all payments on time to avoid late fees and damage to your credit.
Personal loans are a versatile option for covering major expenses, but they are not without risks. Understanding these risks can help you avoid these costly mistakes.
1. Take out a longer or larger loan than necessary
Although long loan terms result in lower payments, a shorter term or smaller loan amount means less interest is paid to the lender, meaning you save money.
A longer loan term means a lower monthly payment and a lower payment sounds good. But there’s a catch. A longer term means that the lender has more time to collect interest from you, so that you spend more in total for the loan than if you had chosen a shorter term.
To illustrate, if you borrow $10,000 at 11 percent for 36 months, here’s what you can expect in terms of monthly payments and loan costs.
| Term of the loan | Monthly payment | Total interest paid |
|---|---|---|
| 3 years | $327.39 | $1,785.94 |
| 5 years | $217.42 | $3,045.45 |
That’s a difference of $1,259.51 in interest.
It can also be tempting to take out a larger loan than you actually need. But don’t make that mistake. The larger the loan, the higher your payment will be and the more interest you will pay in total.
Use a loan calculator to determine if your payment fits your budget. You may have to borrow less or consider a different loan term, but your wallet will thank you.
2. Not shopping around for the best deals
Many lenders have prequalification processes so you can quickly compare rates without hurting your credit. Even if you are short on time, you can still find the best deal.
When you’re in desperate need of cash, it can be tempting to go with the first lender you come across who approves you for a loan. Unfortunately, this can also be a costly mistake. There’s no way to know if you’re getting the best deal or if there are better options.
For example, this is what you pay for a 36-month loan of $15,000 with different interest rates.
| Interest | Monthly payment | Total interest paid | |
|---|---|---|---|
| Lender one | 12 percent | $498 | $2,935.73 |
| Lender two | 8 percent | $470 | $1,921.64 |
Based on this example, getting a loan from the second lender will save you $1,014.09 in interest over the life of the loan.
Prequalification allows you to explore loan options from banks, credit unions and online lenders without impacting your credit score. You can use a loan matching tool to view potential offers in minutes.
3. Not taking into account your credit score
Some lenders have minimum credit score limits. If you do not meet these requirements, it is better to wait before applying and focus on improving your score first.
Lenders want to know if you can afford to pay back what you borrow. That’s why most lenders require you to provide employment and income information. Lenders also look at your credit score and credit history to see how you’ve handled previous loans.
The best interest rates for personal loans – near or below the national average of 12 percent – generally go to applicants with good or excellent credit scores.
The interest on bad credit can be up to three times higher. Borrowers with bad credit often spend hundreds or thousands more in interest than those with good credit who borrow the same amount. The lender may also reject your application.
To avoid surprises, check your credit before applying for a personal loan. If your credit score is on the low side, it’s worth exploring other options to get the money you need. In the meantime, check your credit report and file disputes if you notice inaccurate or outdated information that could be dragging down your credit score.
4. Overlooking costs and fines
Not every lender charges fees, but most will charge an origination fee and late fee. When researching lenders, consider how much it will cost you to borrow in addition to the interest rate offered.
Some loans come with fees that can be costly if overlooked, including:
- Origination fees are the processing fees charged by the lender to originate the loan and typically range from 1 percent to 12 percent of the loan amount. Most lenders deduct the origination fee from your borrowed money, although some add it instead.
- Late payment fees are the amounts you pay if you send the payment after the due date (or after the grace period).
- Returned check fees are the penalties you will be charged if your payment cannot be processed because there are insufficient funds in your account.
- Application fee are charged for the privilege of applying for a loan. Reputable personal loan lenders typically do not charge application fees.
- Fines for prepayment These are the costs that the lender charges if you pay off the loan early. These are also rare from reputable lenders.
You can avoid late and returned check fees if you pay on time and in full. You should also research lenders that don’t charge application or origination fees. Prepayment penalties can also be costly if you plan to pay off your loan early, so avoid lenders that charge these fees if possible.
5. Not reading the fine print
Check the fine print of everything you sign and ask the lender any questions. Otherwise, you could violate the terms of your loan or be surprised by the lender processing automatic payments without your knowledge.
Before the loan closes, the lender will send the closing documents electronically or give them to you for review. The fine print contains information about interest calculation, acceptable payment methods, due dates, and fee schedule. It also mentions whether the lender charges more for certain types of payments or automatically withdraws payments.
You must agree to the terms and conditions and sign the documents before the loan proceeds are sent to you. Depending on the lender, there may be multiple pages that you must review and sign to close the loan. But if you sign without reading, you risk unnecessary fees and fines.
6. Delays in payments
Prioritize on-time payments every time to avoid late fees and damage to your credit.
If you are more than 30 days late, your lender will consider your loan in default and report your delinquency to the credit bureaus. This will appear on your credit report for future potential lenders, landlords and insurance companies to see.
The bottom line
If you decide that a personal loan is necessary, consider your budget and shop around to find the best deal. Finding a loan with a competitive interest rate and affordable monthly payments over a reasonable term will help you avoid spending money unnecessarily.
