Personal loans are often used to consolidate debts, buy cars, finance home renovations, take a holiday or, simply, to fund large purchases. And thanks to modern technology, a personal loan application is a quick and easy process.
But like every financial product, just because somebody offers you something, it doesn’t mean that you should take them up on it. Taking on debt, which is essentially splashing someone else’s cash, is a huge responsibility. So what are the common traps your should look out for when applying for a personal loan? Here are four to watch out for:
Trap 1: Loans too good to be true
In order to stand out from their competitors, some lenders advertise offers that are attractive and exciting. These might include low interest rates, interest-free personal loan deals, and flexible repayment plans.
But use your common sense, and be aware of these marketing techniques. Read the fine print of any personal loan offer carefully. Understand that no lender will lend you money when there is no benefit for them. Figure out the hidden clause before you commit to anything.
An “interest free” personal loan deal, for example, might offer a limited interest-free period. But once the interest-free period runs out, you will start paying much higher interest rates on the outstanding balance.
And always double check the fees involved, especially if you’re borrowing a smaller amount. An establishment fee of $200 on a $1000 loan is a huge 20% in extra costs before you start!
Advertised low-interest rate loans can be misleading, too. Some loans are advertised at their per day rate, which can be misleading and hide much higher charges. A loan that’s advertised at 0.8% per day might not sound much. But if you multiply it by the number of days in a year you’ll discover a much higher hidden rate: 0.8 x 365 = 292% p.a. So always look out for the per annum, or p.a. rate.
Last year, the government passed new legislation limiting the amount of personal loan interest that lenders can charge their customers. But you can still end up having to pay back 100% of a loan in interest and fees. For more on hidden interest rates, read our story How Much Personal Loan Interest Are You Paying?
Trap 2: Choosing a loan that doesn’t allow extra repayments
Make sure you pick the right fixed-loan term to avoid break cost fees. See if you can find a loan that allows for extra repayments, too. Or charges no extra if you pay off your debt early.
Some loans allow you to make extra payments above your scheduled monthly repayments, meaning you could pay less in interest over the life of your loan.
Trap 3: When the timeline is far too long
Check your loan timeline. A shorter loan period means higher monthly repayments. But a longer loan period will ultimately cost you more in interest payments over the life of the loan. And some less reputable loan firms advertise low monthly repayments, without revealing the full loan period.
Choose the shortest loan term you know you can afford comfortably. For example, you might score a lower interest rate to reduce your repayments. But if your loan term is stretched out too long, you could end up paying more interest over the life of the loan than if you’d chosen a higher interest rate over a shorter period.
Trap 4: Loans that are too easy to get
If a personal loan feels too easy to get, that’s a red flag. Some lenders will advertise quick cash loans that don’t require any sort of credit check. This means the lender won’t check on your financial history and your ability to repay a loan before they lend to you. But beware of this trap. These lenders will often slam you with far higher interest rates and other fees. You want a little pushback from lenders to know they aren’t out to fleece you.
Look at your options
At the end of the day, you want a lender that will consider your ability to repay the loan and will offer you fair rates and reasonable repayment terms. Always shop around for a personal loan. Know that if a personal loan has high interest rates it doesn’t necessarily mean it’s a trap. But you don’t want to get locked into a debt that’s unmanageable.
Remember Canstar’s expert research and online tools can help you compare the different personal loans on the market. However, taking out a loan is a personal decision, and one that should be made only after thoroughly going through your finances. It’s not easy money to be splashed on a purchase that you’ll live to regret, while still making hefty loan repayments months down the line.
What if something goes wrong with my personal loan?
Even with well-planned budgets, the unexpected can occur. If you’re having problems with your lender, e.g. unexpected fees, misleading information on interest rates, or think you should not have been given the loan, follow these steps. You might not need to do all three:
- Call your lender or broker as soon as possible and discuss your concerns. Many issues can be solved at this step.
- Contact your lender’s dispute resolution scheme. If you and your lender can’t agree, get independent help to solve your problems.
- Report your lender to the Commerce Commission. This government agency gathers information to identify lenders who break the rules. It doesn’t take on individual cases, but acts against lenders who frequently break the rules.
You can also contact the Insurance & Financial Services Ombudsman Scheme. They resolve complaints about insurance and financial services, and their service is free and independent. MoneyTalks is a free NZ service that provides free and confidential financial advice.
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