If you need money fast, a personal loan may seem like the right answer, allowing you to get a lump sum of money within a few days. Before jumping in headfirst, though, you should understand how personal loans work.
Personal loans have many uses, including consolidating debt, paying for home repairs, or paying major medical bills. Some lenders don’t even ask how you’ll use the money unless you have a high debt-to-income ratio and debt consolidation would bring it down.
You can get a personal loan from a local bank, credit union, online lender, or peer-to-peer lender. You may find it easier to qualify for a personal loan than an auto loan or mortgage, but that doesn’t make it any less important to shop around.
Use these helpful tips to make sure you choose the right personal loan for your situation.
1. Get pre-qualified by multiple lenders
Don’t fall for the advertised rates on bank’s websites and marquee signs. Only the most qualified borrowers get these rates. You should find out for yourself what terms a bank will give you. Did you know you can get pre-qualified for personal loans without knocking any points off your credit score?
Many banks conduct a “soft” credit check during the pre-qualification process. This pull on your credit report doesn’t affect your credit score, unlike a “hard” inquiry. A soft inquiry won’t even show up on your credit report. Personal loan lenders can simply look at your credit history to make a tentative decision about whether to lend you money and how much.
The pre-qualification process may feel like an official loan application because you will still provide your personal identifying information, income, monthly debts, and employer’s information, but it doesn’t result in an official approval. Lenders will send you an offer with conditions you must meet if you choose to take out the loan. You can use these offers to compare your options side-by-side.
Once you choose a loan, you finalize the process by accepting the terms provided. The lender will then ask for satisfaction of the loan’s conditions. Typically, this includes proof of identification, documentation of income, and authorization to perform a hard inquiry on your credit. So long as nothing has changed since the pre-qualification, and your documents back up the information you provided, you should get the terms offered.
Note that when you authorize the hard pull on your credit, your credit score may drop a few points. Make sure to choose your offer wisely to avoid multiple inquiries on your credit report.
2. Compare the APRs
The interest rate a lender quotes you may not be what you pay on an annual basis to carry the loan. The APR is a better reflection of the loan’s true cost. Many banks charge closing fees or other loan-related charges, making the effective interest rate much higher over the life of the loan.
The APR includes such fees as:
- Origination fee
- Processing fee
- Document preparation fee
Always ask a lender what fees it charges for a personal loan, as each bank or lender charges different fees. Sometimes the fees depend on your situation — borrowers with higher credit scores and lower debt ratios may pay fewer fees than borrowers with low credit scores or high debt ratios.
The APR includes the interest rate plus the fees to get the loan. It doesn’t include any charges related to servicing the loan, though. Any charges you pay after closing increase the cost of the loan, such as late payment fees or NSF charges.
While you shouldn’t focus on the interest rate or APR alone, having all the information at your disposal helps. The law requires lenders to disclose the APR when you apply for a personal loan, so it’s easy to see and compare it with other loans.
3. Look closely at the fees to have the loan
Personal loans typically have many fees that, if you’re unaware of them, can eat away at your budget.
The most common fees include:
- Late payment fee
- Check processing fee
- NSF fee
- Annual fee
While it’s uncommon today, look for a prepayment penalty, too. This fee applies if you pay your loan off early. It encourages borrowers to pay the loan off over the full term, allowing the lender to collect as much interest as possible. When you pay a loan off early, the lender loses out on future interest — which is why some lenders make up for it with a prepayment fee. Many states prohibit prepayment penalties, and many lenders have stopped charging them, but it never hurts to ask and read the fine print.
4. Know the ways to save on personal loans
Signing on the dotted line and accepting the funds gives you a new monthly liability. If you look closely at your paperwork, you’ll see exactly how much interest you’ll pay over the life of the loan and how long it will take you to pay it off.
But there are ways to save on interest, assuming you don’t have a prepayment penalty:
- Make more frequent payments
- Pay more than the minimum amount required each month
- Set up automatic payments to avoid late fees or excessive interest charges
- Make lump-sum payments when you have a windfall (tax refund, employer bonus, etc.)
- Look for discounts for making automatic payments
- Avoid charges made for processing checks
Do the legwork before choosing a personal loan
Personal loans have their place, but they aren’t a one-size-fits-all solution. Just because your neighbor got a great personal loan from the neighborhood bank doesn’t mean you’ll get one, too. Take the time to shop around and find the personal loan that fits your financial situation the best.
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