What to Watch Out for When Getting a Personal Loan

by | Dec 17, 2019

With fixed-terms and set monthly payments, a personal loan can be a more attractive option than a balance transfer for those who fear the temptation of a credit card. However, a personal loan isn’t without its potential pitfalls. You need to understand all the common fees before you sign on the dotted line. But first, make sure you’re dealing with an ethical lender! 


Do your due diligence on lenders 

Before you hand over your Social Security number and sensitive information to apply for a loan, you should definitely make sure the place is reputable. Going to a bank or credit union should make that process fairly simple, but it never hurts to do a quick Google search just to read about other people’s experiences borrowing from that institution.

Online lenders can be just as reputable, but you should always do a quick vetting process before applying. Look for simple things like a secure website. Scroll to the bottom and see what security process the company runs. Do a check on Google and with the Better Business Bureau to ensure the lender isn’t associated with scams. Plus, word of mouth is always a helpful tool if a friend or family member has used the lender before. 


Fees, fees, fees

Once you’ve checked that potential lenders are reputable and secure, it’s time to determine who is going to give you the best deal. Sure, the interest rates matter, but so do the fees. And it’s so easy for fees to get tucked away into terms and conditions. 

If a company charges any of the fees outlined below, it doesn’t mean they’re acting unethically. However, you can usually avoid them by shopping around a bit as not all lenders charge them. 


Origination fee

An origination fee is similar to a balance transfer fee. You pay it as a percentage of the loan amount when it’s first disbursed to you. For example, if you borrow $10,000 and get charged a 3% origination fee, you’ll pay $300. Make sure you understand how this fee is being charged as it’s often taken out of the agreed-upon balance before it’s deposited into your account. So in the case of the $10,000 –, you’d only get $9,700 deposited into your account. If you need the full $10k, that’s a nasty surprise. You’d need to work the origination fee into the sum you borrow. 


Prepayment penalty 

Lenders make a lot of money on the interest you’re paying for the loan, so they’re not thrilled when you pay off a loan ahead of schedule. It means they’re losing out on future interest payments. In order to maximize profits, some lenders add a prepayment penalty clause to your contract. It’s generally expressed as a percent of the loan amount, just like with an origination fee. So, again, in the case of the $10,000 — say the lenders added a 4% prepayment penalty and you were able to pay off your loan early; you’d have to pay them $400 to compensate for the interest you would have paid had you not paid off your loan ahead of schedule. Not cool, I know.


Precomputed interest

Precomputed interest is a real pain because it’s essentially prepayment insurance for the lender. Instead of charging interest the normal way (aka simple interest where you pay interest on the actual balance outstanding on the day your payment is due), the lender would charge interest based on the terms of the loan. That means making bigger payments to pay off the loan early doesn’t help. Instead, those go largely to interest, rather than chipping away at the principal balance. 


Tip: Avoid a loan with precomputed interest if you have any plans to pay off the loan early.


Add-on insurance 

Oh, the old upsell routine. Just like when they pitch you a warranty and insurance on your cell phone or computer, you could get pitched add-on products for your loan. The common one is unemployment or credit insurance, which is designed to provide relief if you lose your job while in repayment. There’s a monthly premium you pay on top of your loan’s monthly payment. Honestly, just put that amount (and more) into an emergency fund instead. 

Don’t despair. You can find a lender who doesn’t engage in any of these fee practices. Spend some time doing your research before taking out a loan. You don’t want to get excited about paying off your debt quickly only to find out you got hit with a prepayment penalty. 


How is this different than debt relief or debt consolidation or debt settlement companies?

Click here to learn more about debt relief companies and why it probably isn’t necessary for you to use one. 

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