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Watch Out for These Red Flags When Applying for a Personal Loan

The Motley Fool logo The Motley Fool 4/19/2021 Christy Bieber
a hand holding a piece of paper: Watch Out for These Red Flags When Applying for a Personal Loan © Provided by The Motley Fool Watch Out for These Red Flags When Applying for a Personal Loan

a hand holding a piece of paper: Someone signing loan paperwork and being handed money. © Getty Images Someone signing loan paperwork and being handed money.

Personal loans are typically an affordable way to borrow. They often have a lower rate than credit cards. And since these loans are designed to be paid off over a few years, they give you the chance to slowly pay off big purchases.

However, not all personal loans are created equal. Some payday loans masquerade as personal loans, for example. And some personal loans are offered by unscrupulous lenders offering very unfavorable loan terms.

You want to make sure you don't end up with a loan that you regret. So before you take out a personal loan, be on the lookout for these three big red flags.

1. Your repayment timeline is very short

A short repayment timeline typically comes with really high payments because you have just a few weeks, or a few months, to pay back the loan. The problem with that is you may not be able to afford to make the payments.

This could damage your credit score or cause you to borrow again and get trapped in a cycle of taking out loans over and over. This is what helps to make payday loans the most dangerous type of debt.

2. You'll have to pay high origination fees

Many personal loan lenders don't charge any origination fees at all. While some reputable lenders do charge a small fee to originate your loan, it won't equal a huge percentage of the loan amount.

If you're being asked to pay a large fee -- especially if you're buying a small sum -- you should steer clear. The fee will make your effective interest rate very high, and make paying back your loan very difficult.

3. The loan comes with hefty prepayment penalties

You will want the freedom to pay off your debt early if you can come up with the money to do so. As a result, it's important to avoid a loan with prepayment penalties.

Most reputable lenders won't penalize you if you want to become debt free sooner. There's little reason to settle for a loan that punishes you for being responsible and wanting to get out of debt sooner rather than later.

How to find a good personal loan lender

Watching out for these red flags can help you to avoid a bad lender. But how do you find a good one? The key is to get quotes from multiple different loan providers and compare their:

  • Interest rates
  • Loan repayment timelines
  • Origination fees
  • Terms and conditions (such as prepayment penalties)
  • Qualifying requirements
  • Time to funding

Look for a lender offering you the most reasonable rate and fees. And make sure the repayment timeline doesn't leave you in debt for decades or require you to pay off your debt within a few weeks time. Pay attention to the total cost of the loan as well as the monthly payments and upfront fees. And make sure that you can meet the lender's requirements for loan approval.

Ideally, you'll rate shop and compare these features with at least three different loan providers -- or more -- to find the personal loan that's best for your specific situation.

For more information on payday loans, have a look at our research regarding personal loan statistics.

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