- 5 Things You Need to Do Before Applying for a Personal Loan
- 1. Check your budget
- 2. Stop taking on debt
- 4. Know what you want
- 5. Organize documents
- Preparation pays
- Does Refinancing a Personal Loan Hurt Your Credit Scores?
- 1. Shopping for a New Loan
- 2. Opening Your New Account
- 3. Paying Off Your Old Loans
- 1. Check Your Credit
- 2. Shop Lenders and Compare Loan Offers
- 3. Apply For and Accept a Loan
- 4. Pay Off Your Old Loans
- 5. Confirm Your Old Loans Are Paid Off
- Top 5 Things To Know Before You Take Out A Loan
- 1. Why you need the money (and if there’s a better option)
- 2. All of your loan options, including where to get the loan
- 3. How much you can afford to borrow (and pay back)
- 4. Your credit score (and credit history)
5 Things You Need to Do Before Applying for a Personal Loan
Image source: Getty Images
If you plan to apply for a personal loan, here's how to make it easier.
Personal loans are handy financial products. If you dream of a home makeover, need to get an old car running, or want to consolidate high-interest credit card debt, personal loans can help. Whatever your reason for a personal loan, do yourself a favor — take these five steps before you apply.
1. Check your budget
Dreams are fantastic, particularly if they're realistic. Sit down with your monthly budget and figure out if you have room for another payment. Ask yourself this: After I pay all my monthly bills and put money away for the future, do I have enough to afford a loan payment easily?
“Money for the future” here refers to an emergency fund. Do you have enough put away to cover three to six months' worth of bills? What about retirement? Are you saving for when you won't have a job, but will have a thousand things you want to do and see?
If your income allows you to take care of today's bills while planning for the future, you're on a solid financial footing. It's time to proceed.
Looking for a personal loan but don't know where to start? The Ascent's picks of the best personal loans help you demystify the offers out there so you can pick the best one for your needs.
See the picks
2. Stop taking on debt
Lenders fear one thing: Borrowers who don't repay debt. Here are the red flags they look out for:
- A borrower with insufficient income
- A borrower with too many outstanding debts
- A borrower who carelessly assumes new debt
You can easily tick all three of those boxes if you buy a new car or add debt to your charge cards in the months leading up to the loan application.
Ideally, you won't be taking out a personal loan due to an emergency. However, you may need to apply for a personal loan at some point.
A leaky basement, furnace on its last leg, or new transmission could derail your finances so badly that a personal loan is the best way out.
You may not always have time to prepare for financial challenges. That's why it's so important to keep debt under control at all times, whether you're planning to apply for a loan or not.
An estimated 1 in 5 Americans who check their credit reports discover at least one mistake. And even one mistake could drag your credit score down. The higher your credit score, the better the interest rate and loan terms you are ly to be offered.
If you find a mistake (or mistakes), submit a dispute to the credit bureau. According to the Fair Credit Reporting Act, credit bureaus have 30 days to investigate the item(s) in question. If they are unable to verify the information, they must delete it.
4. Know what you want
Say you plan to refinish your basement. You'd love to do it now, but the job can wait. Knowing what you want in a personal loan before applying is an excellent way to gauge whether now is the right time to take one on.
For example, if your ideal loan has an interest rate of 5.99% with a five-year term, look for a loan that comes close. If all you qualify for now is an interest rate of 9.
99% and a three-year term, your best bet may be to do one of three things:
- Work to raise your credit score.
- Wait until overall interest rates are more favorable.
- Figure out another way to pay for your project.
5. Organize documents
For some, the worst part of the loan process is gathering the documents you need to apply. Make it easy on yourself by having the following documents ready to go.
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- Driver's license or state ID
- Social Security card, passport, or birth certificate
- At least two recent pay stubs
- Tax returns for the past two years
- Recent bank statements
- Mortgage statement, lease agreement, or utility bill (for address verification)
Each lender has a preferred way of doing business, and is ly to request a different set of documents. The faster you can provide the required documentation, the quicker you can learn about the best personal loans available to you.
Here's how taking the time to prepare can benefit you:
- Studying your credit report gives you the opportunity to see what you can improve upon. For example, if your debt-to-income (DTI) is higher than it should be, you know it's time to pay down debt or increase your income.
- Taking the time to improve your credit score means you'll be eligible for lower interest rates and better terms.
- Having a list of existing debts ready makes consolidation easier for you and your lender.
- Organizing your paperwork (such as income statements) can make tax time less stressful.
Personal loans can be tremendously helpful, particularly if you've taken the time to position yourself as a highly qualified borrower.
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Does Refinancing a Personal Loan Hurt Your Credit Scores?
Refinancing a personal loan could lower your monthly payments, save you money on interest and make it easier to manage your bills. Sounds good so far, but there's also a downside. Refinancing a personal loan involves taking out a new loan to pay off your current loan (or loans), which might hurt your credit scores.
Generally, if you make your loan payments on time, this isn't a long-term concern and your scores will rise again. But it's something to be aware of as you're considering refinancing a personal loan.
Find the best personal loans in Experian CreditMatch™.
Here's a look at the three main steps in the loan refinancing process and how each one can affect your credit scores.
1. Shopping for a New Loan
Each loan application you submit could result in a hard inquiry, a record of when a lender checks your credit report before making a lending decision. Hard inquiries stay on credit reports for two years and may affect credit scores for the first 12 months.
When they impact your credit scores, hard inquiries tend to lead to a small drop. The drop is often offset within a few months as long as you're making on-time payments on your new account and no other negative information gets added to your credit report.
Multiple hard inquiries during a short period can increase the drop in scores. However, credit scoring models also know that rate shopping is a financially savvy practice.
With this in mind, some credit scoring models don't consider inquiries from the last 30 days, meaning your applications from last week won't impact your application this week. Scoring models may also count all the hard inquiries that occurred in a 14- to 45-day window as a single inquiry when calculating your credit scores.
2. Opening Your New Account
Opening the new loan you'll use to refinance your personal loans can impact your credit scores in several ways:
- It may shorten your average age of accounts, which could hurt your credit scores.
- If you're taking out one new loan to refinance multiple personal loans, that might increase your scores because you'll have fewer open accounts with balances.
- As you start repaying your new loan, your on-time payments can help you build a positive credit history, which can increase your scores.
3. Paying Off Your Old Loans
The loans you refinanced will be closed once they're paid off. The old accounts will remain on your credit reports for up to 10 years, and any negative or positive information associated with the account, such as late or on-time payments, could still impact your credit scores during that time.
Your scores may be hurt when your closed accounts drop off your credit reports, as that could decrease the length of your credit history and average age of accounts.
Find the best personal loans in Experian CreditMatch™.
Refinancing a personal loan can help you:
- Save money by lowering your interest rate.
- Improve your cash flow by lowering your monthly payment.
- Make managing your debt easier by combining multiple loans.
In some cases, you may be able to accomplish two, or even all three, of these goals at once. However, if you're paying less each month, you might wind up paying more interest overall unless you qualify for a significantly lower interest rate.
You may want to look into refinancing if your credit or income has improved since you first took out your personal loan. Even if your creditworthiness has stayed about the same, if interest rates have generally gone down, that might also be a cue to start shopping.
As you're comparing loan offers, a debt refinancing or loan consolidation calculator can help you determine your overall cost or savings.
These five steps are a summary of the refinancing process, although it can vary depending on the lender and type of loan you're taking out.
1. Check Your Credit
Checking your credit scores can give you an idea of which lenders or loan types might be a good fit for you right now. If you have poor credit, you may want to work on improving your credit before refinancing your personal loan.
2. Shop Lenders and Compare Loan Offers
Whether you're looking for the lowest possible interest rate or lower monthly payments, you may want to submit multiple applications to see which lender offers you the best deal.
Start by making a list of the lenders that offer loans that meet your criteria. Consider the minimum and maximum loan amounts, terms and interest rates that each lender advertises. If you can find information about their typical credit score requirements, that can help you narrow the list.
Experian's CreditMatch™ service can also provide you with multiple lenders and loan offers your credit profile.
Find the best personal loans in Experian CreditMatch™.
3. Apply For and Accept a Loan
Once you've identified good potential lenders, submit multiple applications starting with the lender you think is the best fit. To limit the impact on your credit scores, try to submit all your applications within 14 days.
You can then compare your official loan offers from each lender before accepting the best one.
4. Pay Off Your Old Loans
Some lenders may be able to send the money you're borrowing directly to your current creditors to pay off your loans. Otherwise, the lender might send you the funds, which you can then use to pay off your personal loans.
5. Confirm Your Old Loans Are Paid Off
Don't forget about your old loans until you've confirmed that the accounts have a zero balance and are closed. You don't want to wind up accidentally missing a payment due to poor timing.
Overall, refinancing personal loans may lead to a minor drop in your credit scores due to the hard inquiries from the applications and opening of a new credit account.
Over time, your scores may recover and then increase if you continually make on-time payments on your new loan.
Generally, the small drop is worth it if refinancing can save you money or make managing your loan payments easier.
Want to instantly increase your credit score? Experian Boost™ helps by giving you credit for the utility and mobile phone bills you're already paying. Until now, those payments did not positively impact your score.
This service is completely free and can boost your credit scores fast by using your own positive payment history. It can also help those with poor or limited credit situations. Other services such as credit repair may cost you up to thousands and only help remove inaccuracies from your credit report.
Top 5 Things To Know Before You Take Out A Loan
With emergency savings not always available and debt levels rising, more and more people are turning to personal loans to cover emergencies, pay for medical bills, and consolidate their credit card debt.
Taking out a loan can be a significant financial decision, so it’s best to make it a smart one. Here are five essential things to know before you take out a loan
1. Why you need the money (and if there’s a better option)
Knowing why you need to borrow money, to begin with, is the most critical factor you need to consider before taking out a loan. Borrowing money is a big financial step, and it can help you or hurt you—depending on how you manage it.
The most substantial loan you’ll ever take out is your home mortgage. If you can afford a sizable down payment and it’s a home that is within (or below) your means, it might mean taking out a loan is worth it.
But what about personal loans?
According to Finder, 47% of the consumers they surveyed took out a personal loan to cover bills or emergencies. Borrowing money to pay for things medical bills, a flooded basement, or a dented car is never ideal, so I always recommend building up emergency savings first.
That being said, about 69% of Americans don’t even have $1,000 saved for emergencies (CNBC)—so I understand why it may be a necessity (although this is a deeper-rooted issue to tackle). So, if you must borrow money for an emergency, make sure you follow the remaining four steps below.
The most considerable portion of the people surveyed by Finder showed that they were taking a personal loan to purchase a vehicle (31%). Many people default to looking at auto loans specifically (and many times through the dealer themselves). But, a personal loan can actually be a good solution if you do it right.
If the reason you need the money isn’t exactly an emergency, and you can wait it out a few months (or longer), do it. I strongly recommend you use a tool PocketSmith to help you break the total cost you need into smaller, monthly chunks. Then budget for this more significant expense. It’s a more financially-savvy move to save the cash for what you need.
2. All of your loan options, including where to get the loan
Depending on what kind of loan you need, you will have quite a few options at your disposal.
The quickest and easiest way to get a personal loan is to go to the bank you already have a pre-existing relationship with.
By sitting down with a person and going over a loan application, they can often approve you on the spot. Plus, your loan will be with the same bank, which makes managing the payment a little more comfortable.
But to really save money, I’d encourage you to shop around online. There are many places online that now offer great deals on personal loans. Two of my favorites right now are Fiona and Credible.
Fiona gives you access to low rates to refinance your student loans. They have a simple form you fill out. It asks how much you need, what you need it for, what your credit score is, and your contact information.
From there, Fiona will pull a list of offers for you from multiple lenders so you can choose the best offer for your situation. Fiona makes money by referring you to lenders, and the lenders compete for your business.
This way, you get some of the best rates possible on a loan.
Credible works in a similar way. Credible allows you to consolidate both federal and private student loans, as well as loans with a co-signer (which many services this don’t).
Additionally, Credible offers personal loans, mortgage refinancing, and they even help you compare credit cards.
So as you’re working your balances down on your student loans, Credible has other options to help improve your finances, too.
3. How much you can afford to borrow (and pay back)
Now that you’ve determined why you need the money and that getting a loan is in your best financial interest, you’ll need to think about how much you can realistically afford (and pay back).
The word afford is tricky. Just because you can cover the monthly payment, doesn’t mean you can actually afford the loan. In fact, a recent Harvard study showed that nearly 40 million Americans are living in a home they cannot afford.
Cars are similar. A study by Bankrate showed that most families can’t afford the average new car anymore, while a AAA study showed that 64 million drivers would be incapable of coming up with just $500 or $600 for a car repair.
I don’t share these statistics with you to scare you away from taking out a loan—but I encourage you to reframe your thinking on the word afford.
The first step here is to ignore the APR of the loan for a moment. That’s usually the first thing the loan originator will try to sell to you. And rightfully so—it’s a standard way to compare loans quickly and easily.
But what’s even more critical than the APR is the total cost you’ll pay for the loan, sometimes referred to as the TAR (total amount repayable). This is the amount you borrow plus the interest you’ll end up paying over the life of the loan.
The reason this is important is that an APR can trick you. I’ll give you an example. Say you want to borrow $10,000, and you have two options:
- Option A: $10,000 at 5.00% APR over five years (monthly payment: $188.71).
- Option B: $10,000 at 6.00% APR over three years (monthly payment: $304.22).
Which is the better financial decision? Option A gives you both a lower APR and a lower monthly payment, but Option B is actually the better deal. Here’s how our output looks when using an amortization calculator:
As you can see, Option A costs 11,322.74, while Option B only costs $10,951.88—a savings of $370.86. This amount may seem small, but as your loan amount increases and your term becomes longer, these types of gaps continue to widen.
So when you’re thinking about what you can afford, consider the monthly payment, but most importantly consider the total amount you’ll end up paying back.
4. Your credit score (and credit history)
Now that you know what you can really afford to borrow and pay back, it’s time to figure out what type of loan and rate you can qualify for. Enter the credit score.
Your credit score and credit history are the lifeblood of your financial well-being. Without credit—specifically, good credit—you can kiss low rates, low payments, and overall savings goodbye.
One thing I found particularly shocking was that 45% of college students don’t know their credit score.
A college student is right at the beginning of their credit history in most cases, so I would think this would be the most crucial time to level-set and know where you stand. But it’s not just college students.
MoneyTips found that 30% of the general population they surveyed don’t know their credit score either.
The point is, you need to know your credit score and your credit history. The good news is that it’s easy to accomplish this.
For simplicity, I recommend using free tools Credit Sesame and Credit Karma.
But as a consumer, you’re entitled to get a free copy of your credit report from each of the three credit bureaus (Equifax, Experian, and TransUnion) every year.
MU30 even built a Credit Score Estimator tool so you can estimate what your score should be.