6 Important Questions to Ask Before You Borrow a Personal Loan

A personal loan is handy when, out of the blue, you get an unexpected major expense that can’t wait till your next pay cheque. Most personal loans have a set monthly payment and a repayment time frame. But the cash you borrow adds to your debt, affects your credit and commits a chunk of your future income to loan payments. So, how do you know that borrowing a personal loan is really the way to go? Let’s find out.

6 Questions to Ask Before Getting a Personal Loan

Do I Really Need a Personal Loan?

Start with the reason you want to borrow. Is it an unexpected medical bill, an urgent home repair, a move to a new city or several high-interest credit card balances? These are common reasons to borrow.

However, some expenses deserve a second thought. Borrowing for a vacation, expensive electronics or a wedding can leave you paying for something long after the excitement has passed. If the expense can wait, saving for it may cost less than financing it.

Can I Afford the Monthly Payments?

A lender may approve a loan based on its assessment of your credit, income and existing debts. But its approval amount isn't necessarily what your household budget can comfortably handle.

Before applying, work out how much money comes in each month and where it goes. Include rent, utilities, groceries, mortgage payments, insurance, transportation, existing loan installments, credit card payments and other regular expenses. Leave room for savings and unexpected costs, too.

What's left after these expenses is a better starting point for judging whether you can take on another payment.

What Interest Rate and APR Will I Pay?

The interest rate represents the cost of borrowing the principal amount. The APR gives a broader picture, including charges like origination, processing and administrative fees. This makes APR a more useful figure when comparing similar online loans with monthly payments. You can look for lenders that offer prequalification. This usually involves a soft credit inquiry, which doesn't affect your credit score.

How Much Should I Borrow?

Start your borrowing decision with the expense you need to cover, not the maximum amount available. Because you'll pay interest on the additional amount, too, work out the actual cost of your expense first. If you're borrowing for home repairs, get written estimates from contractors.

Don't put a valuable asset at risk as collateral just to get a bigger loan. You need to think carefully about the consequences. The right loan amount is the smallest amount that will actually meet your need and leave you with an affordable monthly payment.

What Fees and Repayment Terms Should I Check?

Before accepting an offer, read the loan agreement and look for charges that could increase what you owe. An origination fee is one common example. For instance, if you borrow $10,000 and the lender deducts a 5% origination fee, you'll receive $9,500 but may still have to repay the full $10,000, along with interest.

Other charges to check:

• Late payment fees
• Prepayment penalties
• Insufficient funds fees

Many online loans with monthly payments have repayment periods ranging from one to five years, although some lenders offer shorter or longer terms. A shorter term implies higher monthly payments but less interest paid overall. A longer term can make the installments easier to manage, but you'll usually pay more interest over time.

What Happens If I Can't Make a Payment?

Missing an installment can lead to late fees and additional collection activity. Payments reported as 30 days or more past due can appear on your credit reports and hurt your credit scores. Continued nonpayment can lead to default, collections and a lawsuit. If you have a secured personal loan, you could also lose the collateral. Before borrowing, find out how the lender handles financial hardship.

Conclusion

A personal loan can be a lifesaver when you need extra cash to cover a major expense without going into debt with credit cards. The real challenge is repaying the loan. Before you sign a loan agreement, ask these six questions. Compare offers from banks, online lenders and credit unions, read the fine print and never let a tempting loan amount rush your decision.