February 27, 2022

What to Keep in Mind When Taking Out a Loan

Eric Bank
Former Citadel Director of Business Analysis

Many folks approach their first loan application with a sense of intimidation. They wonder whether they can afford to repay the loan and what it will do to their credit scores. 

Relax – don’t fear the lender. Instead, do your homework so that you limit yourself to trusted loan providers and understandable loans. Personal loans are ideal for first-time borrowers because they allow you to affordably finance expensive purchases over a reasonable period. You can use the loan proceeds however you want, such as paying for a vacation or a significant life event (marriage, new child, bar mitzvah, etc.).

What Is a Personal Loan?

A personal loan is also called a signature loan because it depends on your signature rather than collateral. The lender makes the loan based upon your credit score and history, charging an interest rate accordingly. You repay a personal loan in multiple installments, typically over three to 72 months. The installment amount is fixed and charges interest at the stated annual percentage rate (APR). You can pay off the loan early, but make sure the lender doesn’t charge any prepayment penalties.

Even if this is your first loan, you already have a credit score if you ever owned a credit card. Your card issuer reports your payments each month to one or more of the major credit bureaus (Experian, Equifax, and TransUnion) that use the information to calculate your credit score. Timely payments can give you a good score, but late payments can send your score plunging.

How to Apply for a Personal Loan

If your credit is good, you might want to apply for a personal loan from your local bank or credit union. They will charge the lowest interest rates, but they are also the pickiest lenders. That means they may turn down your application if you have little or no credit history or if your credit score is low. Not to worry – the internet features dozens of legitimate personal loan providers and P2P lenders who will work with you. 

To apply for a loan, you’ll fill out a form providing information about yourself, your income, housing costs, and debts. The data requested varies by lender but usually requires only a few minutes to submit. Lenders may want to see documentation, such as pay stubs, rent/mortgage bills, bank statements, and tax returns. 

When you submit your application, a lender will typically pull your credit file from one or more credit bureaus. These are called “hard inquiries,” and they have a small, negative impact on your credit score – a drop of one to eight points for no more than a year. If the loan is approved, you’ll sign an agreement that specifies the payment schedule, interest rates, fees, and other terms and conditions. Read it carefully before signing – you’re under no obligation to take a loan that makes you uncomfortable. Personal loans can improve your lifestyle when used responsibly without tapping into your savings or retirement funds.

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