If you’re thinking about applying for a personal loan, it can be a solid move toward a brighter financial future. But be sure to evaluate your needs and costs associated in order to make the right decision. Ask yourself a few questions in the guide below to help you evaluate personal loan options.
What Is the Likely Interest Rate?
Gather a handful of personal loan options, then compare interest rates. You want to look at this number in two ways:
The Annual Percentage Rate (APR) of the Loan. That’s the amount of interest you’re charged each year. For example, a $10,000 loan with a 15% APR costs $1500 a year in interest.
The Interest Cost Over the Life of the Loan. You can calculate that using the following formula: (Amount Borrowed x Interest Rate x Years to Pay Back) / 2. For example, if you paid that $10,000 loan at 15% APR back over five years, the total interest cost would be (10,000 x .15 x 5) / 2, or $3,750.
Comparing those amounts side by side is the first step in deciding which loan is best for you.
What Are the Associated Fees?
Interest isn’t the only cost associated with loans. You’ll also pay various fees for the privilege of borrowing the money. There are many different kinds of fees, but they usually fall into three broad categories:
Upfront fees associated with originating and processing the loan. Often these are rolled into the borrowed amount. If you borrowed $10,000 with $1,000 in upfront fees, you would be on the hook for an $11,000 loan. You would need to recalculate the lifetime interest cost accordingly.
Real-time fees you pay as you go with the loan. Usually, these are labeled something like “statement fee” or “processing fee.” You pay it each month or year in addition to your regular loan payments.
Penalty fees you’re charged for being late with a payment, paying off the loan early, or some other activity the loan agreement forbids. You can usually avoid these fees, but with some lenders, they can be very steep.
It’s not uncommon for lenders to offer loans at low-interest rates but charge high fees that make the loan’s total cost steeper than a loan with high interest but low fees. Be sure to include these fees in your side-by-side comparison of loans to compare the actual total cost.
What Will the Minimum Payment Be?
This is a simple step but one many potential borrowers forget. Find out the exact monthly minimum payment for the loan, including any real-time fees. You should be able to get this number from the lender’s website. If they’re slow to give it to you, that’s a red flag. Proceed with caution if you proceed at all.
While you’re at it, ask if there’s a discount for automatic payment and electronic-only statements. Many lenders now shave a fraction of a percentage point off your interest if you commit to either.
Do I Need to Do This Now?
A personal loan costs money every month you still owe on it. By contrast, saving up money every month costs you nothing out of pocket and can earn you money if you place it in an interest-bearing account.
If you can put off the purchase, it will cost you less money while also hindering your finances for a shorter period. Personal loans are usually a better deal in an emergency where you can’t wait. Sometimes a one-time opportunity like a dream vacation counts, but usually, it should be something with meaningful consequences if you don’t get the loan.
One exception to this rule is anything that’s reliably profitable for a business, investment, or side hustle. If you can count on the loan’s proceeds earning you more money than you spend on the interest and fees, this can be a good deal — though you might want to look into a small-business loan or line of credit rather than a personal loan in that case.
Can I Pay It Off Early?
Paying off a loan earlier than the stated term saves you interest and makes the loan cheaper overall. This is true whether you pay off the whole thing after receiving a windfall or you just pay $20 more than the minimum each month to reduce the interest.
However, that payoff comes right out of the lender’s profit. Some lenders include penalty fees for early payment to make sure they make their money. Ask the lender directly about this, and confirm that policy is in the final loan document.
