6 personal loan mistakes that could cost you money

Personal loans are a versatile option to cover big expenses but they aren’t without risks. Understanding those risks will help you avoid making these costly mistakes.

1. Taking out a longer or larger loan than necessary

While long loan terms result in lower payments, a shorter term or smaller loan amount means less interest paid to the lender — which means 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 will have more time to collect interest from you, which means you’ll spend more for the loan overall than if you had selected a shorter term.

To illustrate, if you borrow $10,000 for 36 months at 11 percent, here’s what to expect in terms of monthly payments and loan costs.

That’s a difference of $1,259.51 in interest.

It can also be tempting to take out a larger loan than you truly need. But don’t make that mistake. The larger the loan, the higher your payment will be and the more interest you’ll pay overall.

Use a loan calculator to determine whether 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 offers

Many lenders have prequalification processes so you can quickly compare rates without harming your credit. Even if you’re crunched for time, you can still find the best offer.

If you desperately need cash, it could be tempting to go with the first lender you find that approves you for a loan. Unfortunately, this could also be a costly mistake. There is no way to know if you’re getting the best deal or if there are better options.

For example, here’s what you’ll pay for a 36-month, $15,000 loan with different interest rates.

Based on this illustration, getting a loan with the second lender saves you $1,014.09 in interest over the life of the loan.

Prequalification lets you 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 considering your credit score

Some lenders have minimum credit score cutoffs. If you don’t meet these, it is better to wait before applying and focus on improving your score first.

Lenders want to know that you can afford to repay what you borrow, which is why most require you to provide employment and income information. Lenders also review your credit score and credit history to see how you’ve handled past loans.

The best personal loan interest rates — near or below the national average of 12 percent — generally go to applicants with good or excellent credit scores.

Bad-credit interest rates range up to three times as high. Bad-credit borrowers often end up spending several hundred or thousands more in interest than those with good credit borrowing the same amount. The lender might also deny your application.

You should check your credit before applying for a personal loan to avoid any surprises. If your credit score is on the lower end, it’s worthwhile to explore other options to get the cash you need. In the meantime, review your credit report and file disputes if you notice inaccurate or outdated information that could be dragging your credit score down.

4. Overlooking fees and penalties

Not every lender charges fees, but most will have an origination fee and late fee. When you research lenders, consider how much it will cost you to borrow in addition to the interest rate offered.

Some loans come with fees that could be costly if overlooked, including:

• Origination fees are the processing fees assessed by the lender to set up the loan and typically range from 1 percent to 12 percent of the loan amount. Most lenders deduct the origination fee from your borrowed funds, though some add it instead.
• Late payment fees are the amounts you’ll pay if you remit payment after the cutoff time on the due date (or after the grace period).
• Returned check fees are the penalties you’ll be charged if your payment can’t be processed because you have insufficient funds in your account.
• Application fees are charged for the privilege of applying for a loan. Reputable personal loan lenders do not typically charge an application fee.
• Prepayment penalties are the fees the lender charges if you pay the loan off early. These are also rare among reputable lenders.

You can avoid late and returned check fees if you make timely, full payments. You should also research lenders that don’t charge application or origination fees. Prepayment penalties can also be costly if you plan to pay your loan off early, so avoid lenders who assess this fee if possible.

5. Not reading the fine print

You should review 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 they finalize the loan, the lender will send closing documents electronically or hand them to you for review. The fine print includes information about interest calculation, acceptable payment methods, due dates and the fee schedule. It will also say if 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 several pages to review and sign to close the loan. But if you sign without reading, you risk incurring unnecessary fees and penalties.

6. Falling behind on payments

Prioritize making on-time payments every time to avoid late fees and a hit to your credit.

If you’re more than 30 days late, your lender will consider your loan in default and report your delinquency to the credit bureaus. This will show up on your credit report for future potential lenders, landlords and insurance companies to see.

The bottom line

If you decide 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 at a reasonable loan term will help you avoid spending money you don’t have to.