Make sure you can answer these questions before you take out a personal loan.
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Personal loans can be an affordable way to borrow money when you need it -- especially compared with most credit cards or high-interest consumer loans such as payday loans. But you're still going into debt when you take out a personal loan, so you need to be responsible about it.
Before you ask a lender to give you money and commit to paying it back, you should make sure you can answer these six questions.
1. What do you need the money for?
If you could use the funds to help you save money -- for instance, through debt consolidation -- then taking out a personal loan may be a good idea. Personal loans can also be a smart source of funding for expensive purchases you need to make, such as essential home repairs.
But if you're trying to pay for a luxury -- such as a vacation or a big wedding -- think twice about using a personal loan. You'll end up paying interest and making monthly payments for years for something that won't improve your financial situation in the long term.
2. Have you explored less expensive sources of funds?
When you need to borrow money, you want to do so in the most affordable way possible. So make sure a personal loan is indeed the cheapest way to borrow.
Personal loans have much lower interest rates than the standard APR on most credit cards -- but some cards do offer a 0% promotional rate and you may be better off with one of those if you can pay off the loan before the 0% rate expires. Or if you're borrowing for a car or to pay for school, an auto loan or student loan may be a better and more affordable source of financing.
Make sure you consider total loan costs and other borrower benefits -- such as the possibility of loan forgiveness for federal student loans -- when you decide how best to secure funding.
3. Will you be able to pay back the loan?
Unless you're 100% sure you can make every loan payment by the deadline for the entire life of the loan, don't borrow. You'll ruin your credit, risk late fees and penalties, and put yourself in jeopardy of being sued if you borrow money you can't pay back.
4. How long will it take you to pay back the loan?
Many personal loans have a three- to five-year repayment schedule, but some allow you to pay back your loan over a shorter or longer time period. Understand how long you'll be in debt and consider how this will impact other financial goals you may hope to accomplish during that time frame, such as buying a home or starting a family.
5. What are the terms of the loan?
Make sure you don't borrow unless you understand every aspect of your loan. This includes whether the loan has a fixed or variable rate, whether there's an origination fee or prepayment penalties, and what your interest rate and APR will be.
You never want to take out a loan if you don't understand these things, as you could find yourself paying unexpected costs or, if you opt for a variable-rate loan, facing rising monthly payments.
6. How much will the loan cost you?
Finally, you need to know not only what your monthly payments are, but also what the total loan cost will be, including the principal and interest. Only by understanding the total cost of the money you're borrowing can you decide whether the loan is worth it.
Answering these six questions will ensure you can borrow responsibly
By answering these six questions, you can make sure you take out an affordable loan, don't borrow unnecessarily, and don't take out a loan you don't understand. Learn the answers in detail before you sign on the dotted line of a loan application to avoid serious financial trouble.
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