How Do Personal Loans Work?

Knowledge of different fees

Some loans charge fees beyond just interest rate. Here are a couple you may see:

  • Origination fee. Although it isn’t very common, some lenders charge an origination fee. This is typically a percentage of the total loan amount. Look for loans with minimal or no origination fee.
  • Prepayment penalty. A prepayment penalty is a fee a lender can charge if you repay your loan before the loan term ends. Avoid loans with prepayment penalties, because it’s always best to pay off your loan ahead of schedule when you can. The good news is that prepayment penalties are not common in the personal loan industry.

Get the best interest rate

The interest rate you’ll pay on your personal loan can vary based on a couple of factors, including your credit score and lender. Here’s how to make sure you’re getting the best deal.

Improve your credit score

Generally, you’ll get a low interest rate if you have an excellent credit score.

If your credit score needs improvement, don’t stress — you can still get a personal loan for fair credit. These loans generally charge a higher interest rate, but the interest rate will still (usually) be lower than the interest rate on a credit card. There are also several ways to build credit fast, if you’d like to try increasing your score and improving your chances of landing a low interest rate.

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Compare multiple lenders

It’s not uncommon for a borrower to find loan offers with a difference of 8 percentage points or more on the interest rate, even when applying to the best personal lenders. This means that if you apply to a bunch of lenders, offers with APRs ranging from 8% to 16% wouldn’t be unusual. What if you only apply to the 16% APR lender? You’ll never know what interest rates are out there unless you apply to multiple lenders.

Most personal lenders allow you to get pre-approved, which includes checking your interest rates, in just a couple of minutes. An hour or so of shopping around for loans is easy and could save you hundreds (or even thousands) of dollars.

Know how much time you need to repay the loan

It can be tempting to select the longest loan repayment term possible to keep your monthly payments low. However, it’s wise to consider repaying your loan in the shortest time period you can reasonably afford.

Let’s say that you borrow $20,000 to fund home renovations at an 8% interest rate. Repaying the loan over a 48-month term would result in a $488.26 monthly payment, while a 72-month term would come with a $350.66 payment — keeping an extra $137.60 in your wallet each month.

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However, the longer term would result in you paying $5,248 in total interest, while the 48-month loan would have total interest charges of $3,436. By choosing to pay a little more each month, you’ll save $1,812 in the long run.

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