Ten questions to ask before you take out a personal loan
It’s critical that you have a clear repayment plan, whether you’re looking to take out a personal loan to consolidate debt, finance a home improvement, fund your next big trip or pay for a cross-country move.
- How much do I need?
The first step in choosing a personal loan is knowing how much you need. The smallest personal loan sizes begin at around Kshs. 500, but most lenders offer a minimum of Kshs. 1,000 to Kshs.10, 000. If you need less than Kshs. 500, it might be easier to save up extra cash in advance, or borrow the money from a friend or family member if you’re in a pinch.
- Do I want to pay my creditors directly or have money sent to my bank account?
When you take out a personal loan using a bank, the cash is usually delivered directly to your checking account. But if you’re using a loan from apps, a few lenders offer the option to send the funds directly to your Mpesa and skip your bank account altogether.
- How long will I have to pay it back?
You’ll have to begin paying the loan company back in monthly installments within 30 days. Most lenders provide repayment terms between one month and twelve months. Both your interest rate and monthly payment will be impacted by the length of the loan you choose.
- How much will I pay in interest?
Your interest rate depends on a number of factors, including who you are borrowing from, the loan amount and your term (length of time you’ll be paying the loan back). Interest rates can be as low as 3.49% and as high as 29.99% or more. Typically, you’ll get the lowest interest rate when you have a good or excellent credit score and you choose the shortest repayment term possible.
- Can I afford the monthly payment?
When you apply for a personal loan, you have the opportunity to choose which repayment plan works best for your income level and cash flow. Lenders will sometimes provide an incentive for using auto pay and shorter period for repayment, lowering the amount of interest you have to pay altogether.
Some people prefer to make their monthly payments as low as possible, so they choose to pay back their loan over several months or years. Others prefer to pay their loan off as quickly as possible, so they choose the highest monthly payment.
Choosing a low monthly payment and a long repayment term often comes with the highest interest rates. It might not seem like it because your monthly payments are so much smaller, but you actually end up paying more for the loan over its lifetime.
- Does the personal loan have fees?
Personal loan lenders may charge a sign-up, or origination, fee, but most don’t charge any fees other than interest.
An origination fee is a one-time upfront charge that your lender subtracts from your loan to pay for administration and processing costs. It’s usually between 1% and 5%, but sometimes it’s charged as a flat-rate fee.
- Do I have a good enough credit score?
Before you start applying for personal loans, it’s important to know your credit score to make sure you can qualify. Most personal loan lenders are looking for applicants to have a good credit score, particularly online apps. However, if you have an existing relationship with a bank, you may get approved for a favorable deal if you have a good history of paying bills on time and honoring the terms of your past loans and accounts.
- What other choices do I have?
If you’re looking to pay off debt, balance transfer cards are another option.
However, balance transfer cards have a few draw backs, including balance transfer limits (which is often lower than your actual card limit) and balance transfer fees (typically 3%), unless you can get a no-fee alternative.
- How soon do I need the funds?
Some personal loan lenders, deliver funds electronically on the same day you are approved. Other lenders need up to 10 business days. If quick access to money is important for your situation, be sure to select lenders with fast delivery.
- How will a personal loan affect my credit score?
Personal loans are a form of installment credit, whereas credit cards are considered revolving credit. Having both types of credit in your profile will strengthen your credit mix.
Having a diverse credit mix is helpful, but it’s not everything. Some say that adding a new installment loan, like a car loan or a mortgage, can boost your score, but there’s no sense in taking on debt (plus interest) unless you actually need it.
To maintain a good credit score, focus first on the top two most important factors: on-time payments and credit utilization.
While taking on an installment loan is not in itself going to boost your score a whole lot, using a personal loan to pay off revolving debt will cause the most noticeable increase in your credit score. Once your cards are paid off, keep your spending under 10% of your available credit and notice what a difference it makes.
Personal loans are a great alternative to credit cards, but like any financial product, they are most beneficial when you have a plan. When you’ve gone through the above questions, do a soft inquiry on the lender’s website or on a third-party lending marketplace so that you can see your options without hurting your credit score. After you see what you prequalify for, only then should you follow through with a hard inquiry.