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5 Things You Need To Consider When Accepting A Personal Loan

More Americans are looking to take personal loans to improve their quality of life because of the recent pandemic. Due to the complex implications of accepting a loan, we've provided a couple of tips that you should to be vigilant of so that you are well prepared to step into this space.

Rebecca Joanne
Rebecca Joanne

With the country on the road to recovery from last year's pandemic, more Americans are looking to improve their quality of life. A report by Equifax reveals that 39% more individuals are signing up for auto loans, credit cards, and personal loans, as compared to last year. Now, if you're one of the people looking to take out a personal loan, it's important to understand what that entails. While personal loans can help you reach certain milestones, it would be unwise to apply for one without understanding its guidelines and policies. Moreover, to get the most of your personal loan, it's best to come in prepared. That said, here are some factors that you need to consider before getting down to business.

What is Your Purpose for Applying?

Of course, the very first thing you need to consider is the reason behind your loan application. What are your intentions? Personal loans have a myriad of uses including: debt consolidation, home improvement, home relocation, weddings, and even for a well-deserved vacation! Whatever your personal goal, you need to identify and study it so that you can choose the best loan option for your budget and time frame. Simply put, your purpose will serve as a guide in exploring and selecting the best loan that suits your needs.

Another important thing to note is that your purpose for the loan will also determine the principal or the amount you borrow. After all, this is what you’re using the loan for! As such, it's vital to estimate how much money you'll need and look through your loan options before signing on the dotted line.

What is the Interest Rate of the Loan?

After determining your reason for taking out a loan as well as its corresponding principal, the next thing that you need to look into is the loan's interest rate. The interest is what compensates the financial institution for its service, as well as determining the risk of lending the money. With personal loans, the principal and interest come as a package deal, so you’ll need to pay off both amounts over a set period of time. That said, you're going to need to pay close attention to interest rates to help pinpoint the best choice for you.

Besides looking at the percentage, you also need to consider whether the loan operates on simple or compound interest.  The former of the two is more ideal for those taking out personal loans. This is because the interest doesn’t accrue, so you will pay the same amount each month. On the other hand, personal loans working on compound interest can get complicated since you’ll have to pay off all the accumulated interest on top of your principal. Some interest rates accrue weekly or daily, meaning you'll need to pay more, the longer the personal loan is active.

Are There Extra Fees Associated with Your Loan?

Some lenders charge extra fees on top of the interest rates. Be sure to factor in these extra fees and consider how they can impact the cost of your loan. One of these is the origination fee, and it’s usually collected to process your application. Depending on your lender, you'll either pay this fee upfront or have it deducted from the amount you plan to borrow. Aside from an origination fee, you also need to look out for any prepayment penalties. A prepayment penalty is an additional fee incurred when you choose to pay your loan back early. Some lenders include this in their policy to dissuade people from paying back before the agreed-upon date, allowing the loan to continue accruing extra fees from the interest rate.

Given this, it's best to apply for a loan without any extra fees. However, be sure to do the math and estimate your final bill, as some loans with extra fees might prove less costly compared to options with higher interest rates. Don’t let those hidden fees sneak up on you!

How Will You Pay Off the Loan?

Before you take out a loan, you need to look into the future and consider how you can repay the amount borrowed. One factor that lenders consider, and you should, too, is your debt-to-income ratio. This is your monthly debt repayment divided by your monthly income. The ratio is a simple and straightforward way to help you and your lender assess if you can consistently make loan payments within the agreed term. Most importantly, lenders are more likely to approve loans if you have a ratio of 43%, which is the highest ratio a borrower can have.

After considering your debt-to-income ratio, plan your time frame for repayment. Those going for a shorter repayment period will get lower interest rates, but they’ll have to pay larger amounts over time. On the other hand, you’ll be charged with higher interest rates if you go for a repayment period that lasts for years.

How Will Your Credit Score Affect Your Loan Application?

Your credit score doesn't just apply to credit card payments. You’d be surprised to learn that it can also be used as an assessment tool by financial institutions, landlords, and even employers! Generally, the lower your credit score, the less likely you are to be granted a personal loan.

Oftentimes, you’d have to hit a score of 680 or higher to get the trust and approval of most lenders. To raise your score, pay off your dues consistently and keep your outstanding balances as low as possible. It's also vital to pay your bills and loans on time. Maintaining these practices will improve your credit score.

Taking out a personal loan for any purchase is a huge decision to make! But with the sheer number of options out there, it's crucial to know the different factors of a loan application. Make the most out of your loan by considering why you're applying, the loan's interest rates and extra fees, as well as your repayment plan and credit score. When done correctly, you would have chosen the best loan options for you and already have a plan in motion to pay it back effectively.

Personal Finance