What to do before applying for a personal loan
Written by
Writer, Fox Money
Tim Maxwell is a financial writer with over two decades of experience. His byline has been featured by USA Today, Washington Post, Bankrate, CBS News, and Fox Business.
Updated October 16, 2024, 2:45 AM EDT
The economic recovery from the coronavirus pandemic suffered a blow in December, as the U.S lost 140,000 jobs that month. And although the unemployment rate dipped to 6.3% in January, the Bureau of Labor Statistics (BLS) reported that seasonal jobs were responsible for the employment uptick. Surely, the road to recovery will take time before we see numbers like the pre-pandemic unemployment rate of 3.5% in February 2020.
With so many Americans still facing financial hardship, some people may be looking into getting a personal loan. Among the most common reasons to get a personal loan are to consolidate high-interest debt or to finance a large purchase. And for those whose income has taken a hit in the past year, a personal loan can help manage daily expenses or help cover a financial emergency.
- Review your credit reports
- Avoid taking on new debt
- Improve your debt-to-income ratio
- Compare personal loan lenders and rates
- Apply for only what you need
1. Review your credit reports
A mistake on one of your credit reports could negatively affect your credit score and trigger higher interest rates for any loan offers you receive. Since having a higher credit score typically results in better loan rates and terms for borrowers, it’s important to fix credit errors that may be hurting your score.
Every year, you can receive a free credit report from each of the three major credit reporting agencies — Equifax, Experian and TransUnion — at AnnualCreditReport.com. If you stagger your requests to receive a report from a different bureau every four months, you can effectively check your credit report throughout the year.
Carefully review your credit reports and keep an eye out for inaccurate or missing information. Then be sure to dispute any errors you find to get them removed.
HOW MUCH DOES A PERSONAL LOAN AFFECT YOUR CREDIT SCORE?
2. Avoid taking on new debt
Before you apply for a personal loan, avoid signing on for additional credit, such as car loans, home loans or student loans. When your credit report shows several hard credit inquiries in a short period of time, it may be a red flag to lenders that you’re facing financial troubles and need cash right away.
Many times, an applicant who is rejected for a loan can reapply a few months later and obtain the loan once the lender sees they can make monthly payments on time.
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3. Improve your debt-to-income ratio
Your debt-to-income (DTI) ratio indicates the percentage of your gross monthly income that goes towards your monthly debt payments. Typically, lenders want to see DTI ratios under 36% and lower ratios improve the odds of loan approval.
Lower your DTI ratio by reducing your debts and increasing your income. You can accelerate your debt reduction time by making extra payments and by employing repayment strategies such as the debt snowball and debt avalanche methods.
Increase your income by negotiating a higher salary with your employer or by earning extra money with a side hustle.
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4. Compare personal loan lenders and rates
It pays to get the lowest interest rates possible for any personal loan, particularly if you’re facing a financial emergency.
“The lowest possible interest rate is always the ideal, as long as it does not come with hidden fees,” said Ilian Georgiev, CEO and co-founder of the debt management app, Charlie.
Shop around to identify lenders with the best personal loan rates and terms. “Different companies will offer you different rates because they all have different ways of assessing risk,” said Georgiev.
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5. Apply for only what you need
When you borrow money, not only will you need to pay back the original loan amount but you'll also have to pay interest on what you borrowed. Since there’s no good reason to pay interest on money you don’t need, be sure to only apply for what's necessary.
By contrast, if you don’t borrow enough money, you may have to take out an emergency loan in the future to cover your financial needs.
Most importantly, make sure you can afford the loan's monthly payments. The last thing you want to do is make matters worse by financially overextending yourself.
WHAT SHOULD YOU USE A PERSONAL LOAN FOR?
Final thoughts
Consumers use personal loans for a variety of reasons, from debt consolidation (the most popular reason to get a personal loan) to home improvements.
In the wake of the coronavirus pandemic, many people are turning to personal loans to address financial emergencies or to cover daily expenses until they can get back on their feet.