Personal loans are a great way to finance large purchases, emergency expenses, debt consolidation, or home remodeling when you can't afford it upfront. That's mostly because personal loans usually have lower interest rates than credit cards and a majority of the other lending options. There are different types of personal loans out there for various purposes.
However, before applying for a personal loan, you need to consider a few crucial things to increase the chances of getting approved for the loan and help you secure the lowest interest rate possible. One of these factors is your credit score since it shows your creditworthiness to lenders. Fixing your credit report before applying for a loan can help you qualify for lower interest rates and better terms. Here are a few other important things to consider before taking out a personal loan:
1. Type of Personal Loan
There are many types of personal loans available to apply for, depending on how you intend to use it. Personal loans can either be secured or unsecured. Secured loans require you to provide your lender with collateral to secure the loan, while unsecured ones don't need any security. Other types of personal loans include fixed-rate loans that come with a fixed interest rate over the life of your loan and adjustable-rate loans.
Common types of personal loans you can apply for include vacation loans, debt consolidation loans, and wedding loans. Before you take out a loan, assess your financial situation and what you want to use it for to help you decide the best loan type for your unique needs.
2. Interest Rates
Another important thing you need to consider when taking a loan is the interest rate. Determining the interest rate is crucial since it dictates how much you'll pay back. The amount of interest on a loan depends on factors such as your loan amount, repayment period, and your credit score. You can get the lowest interest rate if you choose a shorter repayment term and have a good credit score. You can also get a lower rate with secured personal loans than unsecured loans.
Compare the interest rates of multiple lenders and choose one that offers you the lowest rate possible. This will keep your repayment amount within reasonable limits, so you can pay off the loan faster.
3. Associated Fees and Penalties
Apart from the interest rates, you should also assess your lender's different fees. Typically, your loan can come with numerous costs such as administration fees, processing fees, prepayment fees, appraisal fees, and late repayment fees. Most personal loan lenders will charge you a one-time upfront fee for administration and processing costs, which is often between 1% and 5% of your loan amount or a flat-rate fee. These fees can reduce the amount of loan you'll get in your account since lenders deduct the costs from your loan upfront. Consider all expenses associated with the loan to get a clear estimate of your total expenditure.
4. Repayment Term
Before applying for a loan, you need to know its repayment period. This is important because it determines how much you'll end up paying for the loan. Most lenders' repayment terms range between six months and seven years. A long repayment term comes with lower monthly payments but higher interest rates on your loan. While this option makes your monthly payments easier, you often end up paying more for the loan.
Choosing a shorter repayment period can enable you to pay off your loan faster but at the highest monthly installments. This can also lead to cash flow problems. A short repayment term can work best if you have some safety net like an emergency fund or liquid assets that you can convert into cash and continue repaying the loan in case you experience financial difficulties. Choose a repayment term that works best for your cash flow and income level. Be sure to make timely monthly repayments to avoid costly penalties from your lender.
Endnote
Taking the things mentioned above into consideration before applying for a personal loan can help you make the right decision, increase your chances of getting approved for the loan, and ensure you can repay it without straining your finances. Be sure to evaluate your financial situation, so you can apply for a loan that you can easily repay.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
