Depending on your financial situation, there are several different reasons you might take out a personal loan. It could be used to consolidate debt, to cover the cost of a large purchase, or to pay for an emergency expense.
Personal loans aren’t much different from car and student loans. You can get a personal loan at most banks and credit unions, or from other reputable lenders. A credit check is generally required before approval.
Personal loans are typically unsecured, meaning the borrower doesn’t provide any collateral. As a result, interest rates on personal loans tend to be slightly higher than those for secured loans, such as car loans or mortgages.
Of course, any decision to borrow money requires serious scrutiny on behalf of the borrower before agreeing to take on debt, not to mention paying interest. That doesn’t just mean reading the fine print of the loan agreement – it also means a dose of introspection, and careful consideration of the alternatives.
Here are a few of the key questions any borrower should answer before taking out a personal loan.
Exactly how much money do I need to borrow?
You never want to guess when deciding how much money to borrow in a loan. Too little, and you won’t be able to cover the expense. Too much, and you’ll end up costing yourself in additional interest charges. The size of your loan amount is one of the most important factors in determining the interest rate you’ll pay, so resist the temptation to ask for more than is necessary.
What’s my credit score?
When borrowers have a history of bad credit, it tends to make lenders cautious. In some cases, they may decline to lend money to those clients. Others may get a loan but will have to pay a higher rate of interest, making borrowing more expensive. Before shopping for a loan, try to clean up your credit history by paying off any overdue bills. Start early if possible – it can take several months of responsible payments to rehabilitate a shoddy credit score.
What’s this going to end up costing me?
Besides paying back the loan principal, there are often fees associated with borrowing money, so don’t forget to factor those into your total. In addition, interest charges will swell the amount you end up paying your lender. Some personal loans have fixed interest rates, while others have variable rates that rise or fall, meaning you could end up paying more than anticipated.
Find out what interest rate you’re being offered and work out what the total price of borrowing will be. When you see how much your loan will cost you, consider whether it’s still worth paying that price over the next several years to cover whatever expense you’re facing in the present.
What will the monthly payments be, and can I afford them?
If you borrow money, your loan will require regular payments over a fixed schedule, usually between 24 and 60 months. Take a close look at your monthly budget and make sure you’ll be able to handle those payments. A common financial rule of thumb is that borrowers should avoid spending more than 33 to 45 per cent of their income on paying off debt. Any more than that and your finances are likely to be stretched too thin, leading to cash flow concerns.
What are my options?
Instead of borrowing, can you generate the funds you need by selling something, or by accessing an emergency savings fund? Could you access a line of credit or tap into your home equity to access cash a different way? Could you turn to a friend or family member to lend you the money? Maybe instead of borrowing, it’s wiser to save up over several years – look for an option that keeps you out of a lengthy repayment plan.
