Personal loans are a great way to finance home remodeling or pay down high-interest credit card debt, but they’re not always the most affordable way to borrow money. There’s no collateral, so financial institutions charge higher interest rates to protect themselves against loss.
You can’t do anything to change a company’s rates, but there are a few things you can — and should — do to make sure you’re getting the best deal possible.
Here are three moves all the smartest shoppers make when comparing personal loans.
1. Check your credit reports
It’s a step few people think to take, but it could be the difference between an acceptance and a denial or a low interest rate and a high one. Your credit reports are a history of your financial responsibility and they’re usually pretty accurate, but mistakes do happen.
Clerical errors or identity theft on your credit report can hurt your credit score and your chance at securing a loan. If you don’t check your reports, you might not know the errors exist until your application is denied.
Everyone is entitled to one free credit report per bureau per year through AnnualCreditReport.com. If you’ve already used yours up, you can purchase credit reports from the credit bureaus themselves or through companies offering credit monitoring.
If you notice any incorrect information in your credit report, notify the credit bureau and the financial institution associated with the account. You might want to wait to apply for your personal loan until the matter is cleared up.
2. Compare rates from multiple lenders
You might be tempted to get a personal loan through your local bank or a company you’ve worked with before out of convenience. But if you only check rates from a single company, you have no frame of reference to tell you whether or not you’re getting a good deal.
You’re better off submitting applications to multiple lenders and then comparing what they offer you to see which has the best rates and fees.
Try to get all of your personal loan applications in within a month of each other to minimize the effect on your credit score. Every time you apply for a new loan or line of credit, the lender does a hard credit check that drops your score by a few points.But credit scoring models take normal credit shopping behavior into account, which is why they consider all inquiries that take place within 30 days as a single inquiry.
3. Read the fine print
A personal loan may seem affordable at first glance, but extra fees buried in the fine print can end up costing you more than you anticipated. Some lenders charge origination fees, which are usually a percentage of your loan amount. Typically, your lender subtracts the origination fee from the total amount you’re borrowing, so you end up receiving less than you expected.
If you intend to pay your personal loan back ahead of its normal payment schedule, you should also check for prepayment penalties or precomputed interest. Prepayment penalties are an additional fee, usually a percentage of your remaining balance, that you owe if you pay your personal loan off ahead of schedule. This compensates the lender for the extra interest you would have paid if you’d stuck to the regular payment schedule.
Another way personal loan companies try to discourage paying your loan off early is precomputed interest. This is where the lender calculates upfront how much you would owe in principal and interest charges if you made your minimum payments over the entire loan term. Your payments go toward this total balance, rather than breaking the amount owed down into interest and principal. It’s different from a simple-interest loan where your monthly interest charges are based on your current principal balance.
In theory, if you pay a personal loan with precomputed interest off early, the lender should refund you some of the interest you paid — in that it didn’t “earn” because you didn’t hold onto its money for as long as it expected. But the way the formulas are set up, most of the interest is considered “earned” relatively early on in the loan term, so you end up paying more in interest than you would with a simple-interest loan of the same amount and interest rate. There isn’t a difference if you take the whole loan term to pay off your balance, but you don’t want to get saddled with a loan that has precomputed interest if you plan to pay it off early.
Getting a good deal on a personal loan requires some research and a basic understanding of how interest rates affect your total balance. It’s a more time-consuming approach than just taking out a personal loan with your local bank, but it could save you hundreds or even thousands of dollars in the long run.