Personal loans are loans that can be borrowed from a credit union, bank, or online lender and are paid back in fixed installments or monthly payments. The typical pay back period is two to five years. Interest rates can vary on personal loans and can range from 6% to 36% for prime lenders. Many personal loans aren’t secured, which means you don’t have to have collateral. A secured loan that is backed by a house or car will likely have lower interest rates, but that means you could lose your asset if you default. Regardless of the loan type or rates, you should be aware of common personal loan traps.
You can use the money from personal loans for any number of reasons. Rates on personal loans are typically cheaper than credit cards so they are often used to pay down large credit card debt and consolidate the debt into one payment. Lenders will base the decision on granting a personal loan on a number of different factors, including your credit report, credit score, and the debt-to-income ratio.
The better credit you have, the lower the interest rate. With a bad credit score, you may not qualify for an unsecured loan and may need a secured loan or co-signer. In order to avoid some of the common personal loan traps, you should get some rates from multiple lenders before choosing. It’s important to be aware of common personal loan traps when getting a personal loan so you can make the best decision for your financial needs.
Common Personal Loan Traps
There are a number of common personal loan traps you should be aware of when searching for personal loans so you don’t fall into a bad situation.
1. Excessive Personal Loan Fees
One of the top traps is excessive personal loan fees. There are five basic types of fees when you get a personal loan. The application fee is charged by some lenders in order to cover the cost of running a credit report. The fees aren’t usually very expensive but can add up, especially if you are putting in multiple applications. You don’t get this money back if you don’t get approved for the loan. In order to avoid this fee, you can search for a lender that doesn’t charge an application fee or be pretty sure you will qualify in order to not waste the money.
If you are wasting too much money on application fees, then you may need to add more to your loan amount than you initially needed in order to replace the application fee. The administrative fee will cover the cost of processing the loan paperwork. It can be part of an administration fee or it could be a separate fee. Not every lender will charge an administrative fee, so you can save on this if you find a lender that doesn’t. Some lenders will charge a loan origination fee. This is a fee upfront for taking out the loan that will cover the cost of the application and paying out the funds.
It won’t come out of pocket but will be a part of the loan. These fees can actually be pretty high. For example, if the lender charges a 10% origination fee and you get a loan for $2,000, then you will only get $1,800. Origination fees will vary, so when you are researching on how to avoid common personal loan traps, try to find one that charges a much lower fee. Just like every other bill, if you are late on repaying back your loan you will owe a late fee. This amount will vary and it could be a set amount or a percentage.
The details of your late fee will be in your paperwork. To avoid this, be sure to pay your loan back on time. The last type of fee is a prepayment penalty. If you are thinking you can double the payments to pay it off early, you may need to think again. Some lenders will charge a prepayment fee because it costs them money if you pay it off early.
2. Out of Control Interest Rates
Interest is a huge part of loans and can be one of the common personal loan traps if you aren’t careful. Many personal loans will have high interest rates and there are some terms you will need to know in order to know what you are getting into. Compounded interest is interest that will be added on to other interest. A loan officer will calculate simple interest according the rate, length of the loan, and amount of the loan. Pre-computed interest is interest that is calculated at the beginning and then added to a monthly payment.
This means a certain amount of each payment is applied to the interest and the rest will be applied to the loan. Depending on how the lender sets this up, you may pay off the entire interest before any money actually goes to the principle of the loan. It’s important to understand the type of interest connected to your loan and the rates so you know how any extra payments could affect it and when you are actually paying off the loan.
3. Additional Loan Insurance
During a meeting with your loan officer, you may hear about additional insurance. The pitch will be pretty appealing, but be aware this is one of the common personal loan traps you don’t want to fall for. They will tell you that you need this because if you die during the time when you are paying back your loan, then your family will be in charge of paying back the payments. However, if you have an existing life insurance policy then it will help pay off the loan.
The second additional loan insurance that will be offered is unemployment insurance. This may or may not be worth it, depending on your job security. If you don’t think anything will happen to your job during the life of the loan, then you should feel comfortable opting out of this. However, if there could be a threat to your job then this insurance may be worth it. If you do opt for this insurance, make sure you know what it will cover. Some questions to ask include what qualifies as a reason to use the insurance and how long it will pay if you do become unemployed.
4. Avoid Personal Loan Scams
If you are aware of the common personal loan traps, it can be easier to avoid personal loan scams. There are different ways to recognize personal loan scams if you know what to look for. Lenders need to be registered with the state, so be sure to check that the lender is registered before moving forward.
The specific rules will vary by each state, but any business that offers a personal loan will have to be licensed. It doesn’t matter if the lender is licensed in another state; they need to be licensed in the state you are in because of different jurisdictions. Be aware of any upfront fees before you get a loan. A legitimate lender won’t tell you to pay before you get your money.
While there are fees you can be charged, these will be a part of your loan and they won’t be asked for upfront. In order to avoid any personal loan scams, it’s best to stay away from lenders that demand fees upfront.
Smart Money Tip!
You can’t guarantee anything in life, so if a lender is using the word “guarantee” then you should think something is fishy. A lender that makes a loan sound like it’s guaranteed will be trying to catch you off guard. This is especially true if your credit isn’t that good.
If you don’t have good credit, you could be trying to ignore any warning signs and get a loan through a company that will guarantee you the money. However, the guarantee is likely a sign that the company or person promising your the loan is going to rip you off.
Research the loan company first…
When doing research for short term loan lenders, check the “About Us” section on any websites you come across. There should be a physical address and phone number. You can take it a step further and verify the information using Google Maps. Some lenders will give out information about the leaders in the company, accompanied by short bios that are easy to verify.
Any legitimate business will want to give you this information so customers can get to know them better. A business that will be trying to scam you won’t want to give out any information because the less you know, the harder it will be for you to track them down later after you have been scammed. When looking at websites, be sure to look for bad grammar and misspellings. A business should at the least use proper grammar. A poorly constructed website is a sign of an overseas phishing scam. If you aren’t yet in the market for a personal loan but are getting offers for loans, be cautious.
Watch out for phishing…
Any offers that are unsolicited could be a phishing attempt. Phishing attempts are common personal loan traps that can lead to a lot offinancial problems. These scams are done so in a way to make it hard to say no to, because it seems like such a great offer. If you do want to go with an offer you have received, do your research to make sure that it’s legitimate.
The last step to protect yourself from personal loan shopping traps is to be aware of any lenders that aren’t interested in your credit history. This goes along with lenders that offer guaranteed loans. Lenders have valid reasons for examining credit history, and one that doesn’t want to verify that you can pay back the loan is likely not legitimate. This means the lender could just be trying to get personal information.
5. Falling for False Marketing and Other Downsides of Personal Loans
Falling for scams and other false marketing are two common personal loan traps. It’s important to research ahead of time. There are also some downsides to personal loans. Not everything will be worth financing with a personal loan. If you are just hoping to take a vacation, buy something expensive that you don’t need, or purchase new clothes for school, these items may not be worth financing.
A personal loan should be there for tough times or when a financial investment is there but someone doesn’t have money at his or her disposal. A personal loan is not a financial cure and instead is more like a temporary crutch. It doesn’t address the problem of debt but instead helps cover it up. You still have to pay back the personal loan. Many times individuals will use a personal loan to pay off high interest credit cards but then continue to use that credit card and get into another cycle of debt. If you need cash for a quick payment, such as a medical bill, personal loans are useful. However, you shouldn’t rely on personal loans to solve all your financial problems.
Is Getting a Personal Loan Bad?
Getting a personal loan doesn’t have to be bad and can be a viable option in a variety of different circumstances. If you are trying to consolidate your credit, a personal loan can be a good tool. Instead of many monthly payments, you would have one monthly payment with a lower interest rate than the interest rate on the card. This also works for refinancing student loans.
The interest rate on student loans can be high, but you may be able to get a personal loan with a lower interest rate that will help you pay off student loans faster. Beware that some student loans have tax advantages, where personal loans do not. If you use a personal loan to pay off a portion of student loans, then you don’t have the ability to deduct interest payments when you file income taxes. You can use personal loans to finance a purchase or pay for an event, such as a wedding.
A personal loan may give you a better deal than financing through the seller. A personal loan may also help you to improve your credit. If your credit report just shows credit card debt, then a personal loan will help give you a mix. Different types of loans are good for your credit score. By paying off some of your credit card debt with a personal loan, you may lower your credit utilization ratio. The lowered amount can give you a better score. Paying back the loan on time is also good for your score.
Is It Smart to Get a Personal Loan to Pay Off Debt?
Since one of the popular uses of a personal loan is to pay off debt, you may be wondering if it worth it to essentially get more debt to pay off the debt you currently have. The answer to if it is worth it will depend. If the stack of bills is piling up, then you will need to make decisions. If you are struggling to meet deadlines, you could be paying more in late fees, which just adds to the overall debt. Also, if you are only paying the minimum, then you are racking up more interest you will have to pay over your lifetime.
In this case, it could make sense to pay off debt as soon as possible with a personal loan. Even if you aren’t struggling to pay off the debt, there are still benefits of getting a personal loan as long as you avoid common personal loan traps. If your personal loan has a smaller interest rate, then you can use this to pay off the debt and avoid more interest in the long run. If you are using a personal loan, then you will need to be aware of the pros and cons of paying off the loan early.
One of the common personal loan traps is fees, such as the prepayment penalty. Paying off a loan early may also affect your credit. If you pay it off early, you could see a slight drop in your credit score. This is to encourage customers to pay the entire amount of interest on the loan. If you are paying it off early then you aren’t paying any more interest. When you do consolidate your debts with a personal loan, it makes it easier to track your bill payments. Instead of having multiple payments, you have one single payment.
Personal loans can be a great tool to use under the right circumstances. As long as you are aware of common personal loan traps, then you can find a loan that will help you with your financial situation. Personal installment loan traps shouldn’t discourage you from getting a personal loan. Be sure to do your research. There are plenty of online lenders that may give you better interest rates, so don’t discredit online lenders. Just like with any loan, researching online lenders will help you avoid the common personal loan traps and get the money you need.
Kevin Strauss is a personal finance writer and homeowner based in the Los Angeles area. Being in one of the most expensive markets in the country, he’s learned to maximize resources to plan for both his monthly expenses and future financial needs. Kevin has a passion for helping those in a similar situation navigate the complex world of personal finance so they can pay down debt, plan for the future and live out their dreams. In addition to covering personal finance in depth on Loanry.com, Cashry.com, Debtry.com, Budgetry.com, Billry.com, Creditry.com and Taxry.com. Kevin shares his expertise with readers who want to create budget-friendly habits across the web.