Applying for a personal loan can be a little daunting, and many feel confused by the process. However, it is crucial to take your time to ensure that you’re making the right financial decision.
Whether you’re planning a major purchase or want to reorganize your finances, you should ask some important questions before you begin the application process.
1. What’s My Credit Score?
In this chart compiled with LendingTree customer data, you can see that those with a 720+ credit score pay an average of 7.63%. At the other end of the scale, for those with a poor credit rating of less than 560, the rate shoots up to an eye-watering 113%.
Before you start applying for any form of credit, you should know your credit score to ensure that you could qualify. While most personal loan lenders want applicants with good credit scores, some lenders specialize in offering loans for those with less than perfect credit.
However, each time you apply, the lender will initiate a hard credit pull, which can negatively impact your credit. So, it is important to only apply to lenders most likely to approve your application.
Fortunately, several services allow you to check your credit score. Once you know your score, you can target lenders who will cater to your credit profile.
Bear in mind that if you have an existing relationship with a bank, credit union, or lender, they may consider far more than your credit score. So, if your score is not ideal, don’t lose hope, as lender options are available.
2. What Loan Amount Do I Need?
You first need to decide how much you need to borrow. Once you start the application process, it is easy to become distracted by financial institutions offering you more or less than the figure you have in mind. Therefore, it is essential that you have a firm figure in mind of what you need for your financial goals.
While it may be tempting to borrow more than you need to have some fun money, you will start paying interest on this amount immediately. So, take some time to calculate what amount you actually need and avoid mistakes that can cost you.
If you’re planning on making a significant purchase, do a little window shopping to determine how much you can expect to pay. If you want to reorganize your finances, get up-to-date account balances and calculate exact figures.
Remember that a personal loan may not be the best option if you only need a small amount of $1,000 or less.
3. How Long Will I Have to Pay It Back?
You also need to think about your loan term. You will need to repay your lenders each month within 30 days of your loan being finalized. Lenders typically offer a repayment term of six months to seven years, depending on how much you borrow and specific lender criteria.
It is important to note that while a longer term will reduce your monthly payment, the longer that you hold the loan, the more interest you will pay across the lifespan of the loan. Many lenders do offer a slightly lower interest rate if you take on a longer-term; You need to look at the total interest cost.
If you can afford it, it is better to take on a shorter-term loan to pay less interest in the long term.
4. Can I Afford the Monthly Repayment?
This question follows the previous question, but you must ensure that you can comfortably afford your monthly repayment plan.
As discussed above, taking on a shorter-term loan is better to avoid paying more interest, but this only works if you can afford monthly repayments. There is no point in saving $5 a month over the lifetime of the loan if you repeatedly get stung with $35 late payment fees.
Some lenders such as SoFi and Lightstream will offer an incentive if you sign up for autopay for your monthly repayments. This could lower your APR by as much as 0.5%. This has several advantages, including reducing the monthly repayment cost, reducing the total amount of interest, and helping you to avoid late payment charges.
If you’re unsure how much you can afford each month, you’ll need to look at your typical monthly expenses. A good rule of thumb is to spend less than 43% of your monthly income on debt.
This should include your mortgage, car loans, and personal loan repayments. For example, if your monthly take-home salary is $3,500, ideally, you should keep your total debt obligations at less than $1,505 each month.
5. How Much Interest Will I Pay?
Lenders calculate interest rates using different algorithms. While other lenders may have algorithms, several typical factors are considered to determine your eligibility, including your credit score, loan amount, loan term, and employment status.
These factors are used to determine your unique risk profile. If the lender determines you’re a higher risk, you’ll be offered a higher interest rate. However, the reverse can also apply, so if you’re low risk, you’ll be provided the most attractive rates.
Interest rates for personal loans can be between 3.49% and 29.99% or more, depending on your risk profile and the lender.
There are a number of reasons for taking out a loan, but this can also influence the average loan amount. In this chart with LendingTree customer data, you can see that credit card refinancing has the highest average loan amount followed by debt consolidation.
Don't fixate on the percentage rate when considering how much interest you will pay. While this is important, your offer terms and conditions will detail how much interest you will pay over the lifetime of the loan. This will allow you to compare loan terms and packages from other lenders.
6. Will the Personal Loan Have Origination Fees?
Origination fees are an upfront, one-time charge that the lender typically subtracts from the loan amount to pay for processing and admin costs.
Origination fees are usually 1% to 5% of the loan amount, but some lenders charge a flat rate fee. For example, if you take out a $5,000 loan with a 5% origination fee, you could only receive $4,750, and the lender would retain $250 for the origination fees.
Some lenders do impose origination fees on personal loans, while others only charge interest, so it is essential to check if a personal loan will have these fees.
It is best to avoid loans with origination fees, but if you check the small print of your loan deal, you may find a lender who imposes an origination fee offers a better overall deal than lenders who don’t charge these fees.
7. How Quickly Do I Need the Funds?
If you are planning a purchase, you may have a more flexible time frame than those who want to reorganize their finances. If you’re looking to consolidate your debt, the longer the loan processing takes, the more interest you will incur on your debts. So, you will need to consider how quickly you need the funds.
Fortunately, many personal loan lenders aim to process applications quickly. Since the loans are unsecured, the entire process tends to be far quicker than secured loans and mortgages. In many cases, you can get an approval decision within hours, but the time for funding the loan can vary greatly.
If you are in a hurry to get your loan funds, you need to look at lenders who will fund the loan the same day or within one working day of approving your application.
However, if you’re not in a particular rush, there is no advantage to getting a quicker funding loan if it has a higher rate or less advantageous terms.
8. Do I Want the Money to Pay My Creditors Directly?
Most personal loan lenders will deliver your funds directly to your checking account. You’ll provide your bank account details during the application process, and upon approval, the lender will initiate an electronic funds transfer.
However, if you want to use your loan for debt consolidation, choosing a lender who will send funds directly to your creditors may be advantageous. There are several benefits of this.
Firstly, since the funds will go to your creditors, they will get to them more quickly than if you needed to wait for the funds to hit your bank account and send out payments. However, another significant benefit is that as the funds will bypass your bank account, there will be no temptation to use some of the funds for other purposes.
Several lenders offer this service, usually included with no fees or charges. However, it is worth checking the terms and conditions to ensure you are not paying extra for this service.
9. What is the Difference Between a Joint Application and Having a Co-signer?
If you have less than perfect credit, you may consider having a family member support your application. However, many people are confused about the differences between a joint application and having a co-signer.
A joint application means that you will put two names on the application. The lender will consider the risk profile of both applicants and adjust the rate accordingly. However, while both parties are financially responsible for the loan, both have access to the funds.
On the other hand, a co-signer is simply in support of your application. Your co-signer needs to be someone with good credit, and by co-signing your loan, they agree to take financial responsibility if you default.
If you’re considering adding someone to your loan account, you must consider which is best for your circumstances. Generally, a joint application is only appropriate for couples or family members who want to share the loan responsibilities and funds. A co-signer may be a better choice if you need someone to support your loan application.
10. Where Can I Source a Personal Loan?
Several financial institutions offer personal loans. The income and credit score requirements can vary greatly, along with the terms, so choosing a lender best suited to your circumstances is important.
- Online Lenders: Online lenders have become increasingly popular, as you can shop for loans at any time of the day or night. However, you’ll have better chances of qualifying if you have good credit and a steady income.
- Banks: Banks typically have higher income and credit standards, but if you have an existing relationship, your bank may consider more than these factors to help you qualify.
- Credit Unions: Credit unions typically favor membership standing rather than just relying on your income and credit score. They also tend to offer more flexible terms.
11. Does the Lender Have a Good Reputation?
It is essential that you trust the lender you will borrow funds from and work with for your personal loan. You need to be confident that you can approach the lender if you have any queries or questions. You also need to know that the lender is transparent about possible costs or fees.
While it may be tempting to go with an unknown lender if they offer a better deal, this can be a costly mistake in the long term. If you’re not familiar with a lender, it is worthwhile to take a little time to research them.
Check the company on consumer review websites to see any red flags. Remember that many people will complain about minor gripes, but if there are multiple complaints about the same issue, it could highlight a potential problem with the lender.
12. Can I Repay the Loan Early?
While you may not have any current plans to repay the loan early, it is worth considering if this is a possibility. Whether you need to refinance the loan in the future or have a windfall and want to clear the loan, it is crucial to be aware that you may incur a fee.
Some lenders charge an early repayment penalty if you make payments over the regular schedule. This is often a percentage of the outstanding loan amount, which can quickly add up. For example, if the early repayment fee is 3% and you have $5,000 remaining on your loan balance, you’ll incur a $150 fee.
However, many lenders do not charge an early repayment fee, meaning you can repay anytime without incurring a penalty.
13. What Documents Will I Need?
When you’re taking out a personal loan, most financial institutions will require that you support your application with some documentation. The details you provide will help the lender to build a picture of you and your overall eligibility. Lenders will require that you provide your full name, address, date of birth, and contact information.
However, the lender has a responsibility to ensure you are a legitimate applicant by providing proof of identity and proof of address. These can include providing a copy of a government-issued ID such as a driver’s license, passport, or certificate of citizenship. The lender may require a copy of a rental agreement or lease documents, a utility bill, or your voter registration card to prove your address.
Finally, the lender needs to know that you have a stable income and employment to make your loan payments on schedule. Depending on the loan and lender, you may need to provide recent pay stubs, previous W-2s, or personal tax returns.
14. Will A Personal Loan Impact My Credit?
Applying for a personal loan will appear as a hard inquiry on your credit report. If you have a number of hard inquiries within a short period, it can be a potential red flag to lenders and thereby hurt your credit. However, many lenders can allow you to check rates with only a soft credit pull, so you can be aware of the potential impact before you apply.
Once you have a personal loan, it will affect your credit. Your credit utilization rate is likely to be affected, mainly if you are not using the funds to clear existing debts.
However, each time you make a monthly payment on time, it will be logged with the credit bureaus. So, the longer you responsibly manage your loan, the more you will see an improvement in your credit.
15. What Are the Personal Loan Alternatives?
Finally, before you go ahead with a personal loan, you should check if alternative finance methods would be more appropriate. The other ways to access funds include:
- Credit Cards: If you can repay the loan amount quite quickly, low interest or 0% credit card could be a better option. You could have greater flexibility and minimize the interest charges.
- Overdraft: If you only need the funds as a short-term loan, an overdraft could be a more suitable finance method. You can arrange this with your bank and discuss what fees or charges would apply. Always keep in mind the risk and potential implications.
- Home Equity Loan: If you have equity in your home, you could take out a home equity loan or personal line of credit. Just be aware that your loan will be secured on your home, and since it is secured, the application process will involve an appraisal so it will take longer.
- A 401k Loan: You may be able to borrow against your retirement plan, depending on the company. You won’t need to worry about interest payments or your credit score, but a portion of your investments will be sold to fund the loan. This means those funds will not be invested during the repayment period, impacting your plan's potential growth.