There’s a universal truth for every human: Each of us will make a mistake at some point. And unfortunately, money mistakes can be especially impactful.
While personal loans can be an excellent financing option if you need fast funding, understanding the possible pitfalls that come along with them before you borrow is important. Here are common personal loan mistakes and how to avoid them.
Even if you’re offered a large sum, it’s not recommended to borrow more than you need. While the spare cash might be convenient, your long-term costs can quickly erode the benefits of having the extra financial cushion.
Personal loans have lower interest rates than some other forms of financing, but you’ll still pay interest — and potentially fees — on the amount you borrow. Let’s say you only need a $7,500 loan, but you borrow $10,000 instead. Here’s a look at the cost difference over a five-year repayment term with a 9% interest rate:
These numbers don’t account for fees, either. Some lenders charge an origination fee, generally structured as a percentage of your total loan and deducted from your loan funds prior to disbursal.
Read more: Taking out a personal loan? How to avoid overborrowing.
In addition to interest charges, some lenders charge origination fees for personal loans. These percentage-based fees can be as much as 10% of your total loan amount, though actual charges will vary by lender. Because origination fees are typically an upfront cost, you must account for them in your requested loan amount.
For instance, if you need a $10,000 loan to cover a specific expense and your lender charges a 5% origination fee, you’d only receive $9,500 in your account after the fee is deducted. In this case, you’d need to borrow around $10,527 to get the full amount you need.
Note that not all lenders charge these fees, so it may be possible to avoid the added cost altogether. Borrowers with good or excellent credit will have the easiest time avoiding an origination fee.
Another significant mistake is applying for the first loan you come across. Interest rates, repayment terms, loan amounts, and fees vary by lender, so comparing personal loan offers is essential. Review loans from at least three different lenders, and research options from local banks, credit unions, and online lenders.
Note the different loan amounts, rate ranges, terms, and fees in a simple spreadsheet. Then reference that data when you decide to formally apply for a personal loan.
Related: What’s the best place to get a personal loan?
Most lenders allow you to prequalify for a personal loan, which gives you a glimpse of your potential loan terms. When you prequalify, you submit some basic personal and financial information to a lender. In return, the lender will give you estimated rates and loan terms you’re likely to qualify for — typically with only a soft credit check.
Prequalifying is an important step before you apply for any type of loan, as it can help you more accurately compare your personalized options. Plus, it could help you save on interest over your loan term; even a half-percentage-point difference in rate could mean significant savings.
Two things are true about personal loans: Shorter-term loans often have lower rates, and you’ll generally pay more in interest over a longer term, no matter your rate.
Lenders often give you a lower rate with a shorter-term loan because they can more easily predict if you’ll be able to afford your monthly payments over a smaller timeframe. Essentially, short-term loans are less risky for a lender.
A longer-than-needed repayment term may result in a higher interest rate and increased interest costs over time.
Read more: How to choose the right personal loan term length
One of the biggest perks of personal loans is how flexible they are: You can use a personal loan for almost anything. However, it’s important to carefully consider your loan’s purpose before you get into debt.
Do you need a personal loan to help improve your financial situation? This could be the case if you’re borrowing to consolidate high-interest credit card debt. Similarly, if you’re borrowing to make some needed home improvements, you could see a return on your investment when it comes time to sell your property.
In some cases, a personal loan can also be a lifeline. You might need fast cash for urgent car repairs or unexpected medical or vet bills. In emergencies like these, a personal loan is often a far safer — and more affordable — option than high-cost payday loans.
However, if you’re thinking about borrowing to fund a vacation, concert tickets, or other nonessential splurges, proceed with caution. Using debt for short-term pleasures can leave you paying the price long after the fun is over.
While the mistakes above can be harmful to your finances, the most damaging thing a borrower can do is miss their monthly payments.
Lenders frequently use the FICO credit model to evaluate borrowers, and payment history is a major factor — accounting for 35% of your FICO credit score. Late or missed payments can harm your credit score for up to seven years, which may make it more difficult to rent an apartment, find affordable insurance, and qualify for a mortgage or credit card.
Once you take out a personal loan, consider setting up automatic payments to avoid missing payments. Some lenders, such as LightStream, will even offer an interest rate discount if you enroll in autopay.
Read more: What happens if you default on a personal loan?
This article was edited by Alicia Hahn.
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