Five Things to Consider Before Getting a Personal Loan

Taking on a personal loan can be a huge commitment that changes how you think about your short-term finances. If you are applying for a personal loan for the first time, then there are some things you should understand before applying that can help you understand your commitment. It’s important not to take on any debt you can’t afford, so it’s essential to understand these things before starting.

Here are the five things you should consider before applying for a personal loan:

Know Your Current Credit History

A big factor in your getting approved for a personal loan is going to be in the details of your credit history. Many lenders won’t give you a personal loan without a cosigner if you have filed for bankruptcy within the past few years, for example. Even if you haven’t had something as serious as bankruptcy, the lender you choose may have questions that you need to answer that show up on your credit history.

To fully prepare for the loan it’s important you understand your own credit history so that you can properly answer any questions that arise. Not having a good reason for any potential flags in your credit history can reflect poorly on your potential as a borrower. Plus, if you have more serious matters in your history, it’s important to know if it automatically disqualifies you from the loan. 

Calculate Your Debt-to-Income Ratio

Another major factor in getting your personal loan approved and determining how much you’ll receive is your debt-to-income ratio. This is simply the calculation of how much of your income is taken up by the debt or payment obligations that you currently have. If your ratio is too high, then it damages your ability to make loan payments, especially if you lose any portion of your income due to an employment issue. 

The debt-to-income ratio is taken by adding all of your debt payments together and dividing that number by your monthly income. For example, if you have $3,000 in debt payments this month and a total income of $10,000 then your debt-to-income ratio would be 30% (3000/10000). While you should discuss the right ratio for your situation, many experts recommend not being higher than around 40-43% to take out a loan and much less when factoring in how much you can responsibly borrow. 

Decide What Monthly Payments You Can Afford

Before committing to a loan, and the payments that come with that loan, it’s important to know what you can truly afford. You should have a number (for both the total loan amount and the monthly payment that you’ll make) that you can’t go over in order to feel confident that you can make the debt payments, even if something bad happens for a few months like you end up losing your job. 

This number can be determined by taking a close look at your budget and understanding how much you pay while still being able to have money each month for unexpected expenses. You never want to budget every penny with a debt payment because there needs to be a little bit of breathing room to account for the unexpected. This is due to the fact that missing a single payment on a personal loan can damage your credit and put your personal assets at risk. 

Know How Much Money You Need

Before applying for a loan you should know the purpose that you’re borrowing money for and how much money you actually need to make that a reality. For example, if you’re borrowing to remodel your home, get quotes from contractors and know how much you need to borrow to make it a reality before applying. You don’t want to pay interest in more money than you actually need. 

Paying that extra interest, depending on how much you borrow, could cost you hundreds or even thousands of dollars more over the life of the loan. The amount you need and your monthly payment on the loan are two things that go hand-in-hand. If you can’t afford the payment on the amount you need then you may need to find another solution to go with your loan (such as saving a bit more first). Likewise, you also shouldn’t borrow more just because you can afford the payment. 

Understand Your Liability for the Loan

Before taking out a personal loan, it’s very important to understand what you’re getting yourself into. With virtually every personal loan, you will sign what is known as a personal guarantee. This means that you are agreeing to repay the loan in full and if you can’t do that at any point in time, then your personal assets could be at risk in order to make the lender whole again. 

So, before you ever take out a personal loan, you need to be okay with not just being able to make the payments but with what you could potentially lose if something unexpected happens. For many, it means they could lose their house or be forced to sell it if they fail to make payments on a loan of substantial size. It’s important to weigh what that guarantee could mean for your own personal assets. 

Bottom Line

When considering taking on a personal loan, it’s important to understand how it works, what you’ll be putting at risk, and how much you can afford to repay. The more confident you are in these things, the more likely you are to make a sound financial decision.

Whether you’re ready to take out a personal loan or not, DECU is there to help you better understand and navigate the entire process. Our loan specialists can help sort your situation out and get approved for a loan that fits you.