6 Personal Loan Mistakes to Avoid

The personal loan market is on fire. As of the first quarter of 2023, total loan balances are more than $225b. There are over 22 million Americans with unsecured personal loans, more than at any time before.

The increase in personal loans financed isn't because borrowers found new reasons to borrow money. Debt consolidation, home improvement costs, unexpected expenses (medical and otherwise), and paying for major purchases remain the top reasons for taking out a personal loan. What has changed is the number of lenders who are offering loans and how effectively they market them. 

Whatever the reason that you want a personal loan, avoid these six common personal loan mistakes to protect yourself from taking out a loan to meet a goal or solve a problem and end up causing yourself a bigger problem.  Pay attention to the tip that follows each mistake, too!

The Six Common Personal Loan Mistakes

Don't Make These Six Personal Loan Mistakes

Mistake #1: Borrowing more than you need

Do you need to borrow the maximum amount a lender offers you? Remember, it’s not free money. If you take out a personal loan for more money than you need, it will cost you in three ways.

• You pay more in interest. With a personal loan, you pay interest on the principal amount you borrow from the time your loan is funded. That is different than a personal line of credit, where you pay interest only on the money you use. The higher the loan amount, the more interest you pay.
• Higher fees. Many personal loans come with an origination fee, taken right of the top. If you take out a loan for more than you need, you will pay a bigger origination fee.
• More debt. If you borrow more than you need, the money you borrow will be spent on something, perhaps something you don't really need. That puts you deeper in debt.

Tip: Be thoughtful and deliberate when deciding how big a loan to apply for. Lenders don't want you to default on the loan, but they have an incentive to get you to borrow as much as possible. Calculate your actual need and don't borrow more. If you are borrowing for a major purchase, have you shopped around to find the best price? Don't round up a loan to $9,000, for example, if you need $8,200.

Mistake #2: Taking on too large a payment

Although this may seem obvious to you, this is one of the common personal loan mistakes borrowers make. Don't agree to make a monthly payment that is more than you can comfortably afford. Lenders calculate your debt-to-income ratio to determine the size monthly payment you can afford, but they don't have a full picture of your monthly expenses. They pull your credit report and look at the debts that appear there (credit cards, mortgage, auto loan, student loans). If you rent, they ask you how much you pay. Lenders don't look at your costs for food, utilities, gas for your car, insurance or other expenses that don't appear on your credit report. 

If you are offered two loans for the same loan amount, it can be tempting to choose a lower interest rate loan, even though it comes with a shorter repayment term and a larger monthly payment. Be extremely cautious before choosing a loan with a rate of 0.5%  lower, but a monthly payment hundreds of dollars higher. 

Tip: Do the math yourself; don't rely on a lender's approval as proof the payment is affordable. Have an accurate budget which includes your income and all your expenses. That is your best protection for avoiding committing to a payment that is going to stretch you too far. You can always choose to pay off the loan faster and reduce your overall interest costs, by making a larger monthly payment, as most personal loans don't come with a pre-payment penalty.

Mistake #3: Not shopping around

The best way to find a loan with the lowest interest rate and fees is to comparison shop. When you need money, and someone offers it to you, it is tempting to take it, if the deal seems reasonable. But how can you know if it is a good deal if you don't see what other lenders are willing to offer you?

Tip: Check out Bills.com Personal Loan Calculator

Personal Loan Calculator

Advertising Disclosures

Calculate estimated payments, then check with lenders for more personalized rates.

How is your credit?

Excellent (720-850)Good (660-719)Fair (620 - 659)Poor (Less than 620)

Loan Amount$10,000

Loan Term (months)36

Monthly Payment

Estimated APR undefined

Compare personal loan rates

Get Started

Mistake #4: Accepting a smaller loan than you need

It is common for lenders to tell you that they will offer you a loan but approve you for a smaller loan amount that you applied for. If you are taking out a loan to solve a specific problem or to achieve a specific goal, don't borrow money that is insufficient to do it. Tip: Each lender applies its own underwriting rules. There are similarities in how different lenders view you, but it is certainly possible that one lender will offer you a larger loan than another. Checking with multiple lenders is the best way to see if one is willing to lend you more than another. 

Mistake #5: Harming your credit score

There are times when a need to take out a personal loan arises unexpectedly. Unforeseen medical expenses, or some other urgent need, can't be anticipated (this is the very reason to have an emergency fund). However, in many cases, you know that are going to apply for a personal loan well in advance. For those instances, be sure to avoid taking steps that harm your credit.  Don't apply for new lines of credit in the months leading up to your personal loan application. It's a red flag to lenders if they see that you opened new credit card accounts recently or if you are applying for other personal loans. Aggressively applying for credit harms your score, reducing your chances of loan approval and costing you more in interest due to a reduced credit score.  Tips: Do your preliminary personal loan shopping with lenders that start with a soft-credit pull. Soft pulls are not visible to lenders and have no effect on your credit score. Rates can change from what a lender tells you may qualify for, based on a soft pull, and what you are offered after you submit a formal application which includes your proof of income and other supporting documents. That can be frustrating, but keep in mind that applications come with hard pulls of your credit. These can lower your score and are visible to other lenders. The other side of the coin of not harming your credit is to take steps to improve your credit score. When you know you are going to apply for a personal loan, take a look at your credit report to see what you can do to improve your score, to boost your chances of approval and to get a better interest rate. Dispute any inaccurate information that's harming your score. Pay down your credit card balances. This lowers your credit utilization and boosts your score. 

Mistake #6: Not asking questions

Loan officers are not mind-readers. Their focus may be on moving you along as quickly as possible and closing the loan. Even when they have your interests in mind, it is foolish to keep your mouth shut. Any question you have is worth asking, and ask a second or third time if the answer is not clear. Best to ask questions before you sign any paperwork. Tip: Here are two questions you should always ask before you apply for a loan.

1. "How close is my credit score to getting me a better rate?" Lenders look at your credit score and place you in a bucket. For example, lenders may have a cut off at a FICO score of 680, giving a better rate to you if your score is 680 than if it is 679. Your 679 score could be grouped with borrowers with scores from 641-680. A lender may tell you that you need to boost your score only a few points to get a better rate. It could be worth delaying your loan application a month or two and boosting your score, depending on how close you are to a better rate. This is especially true if you can improve your credit utilization. It accounts for 30% of your credit score and is the easiest part of your score to change with quick action. This credit score question is also a good point for comparing lenders. One lender may tell you that you need a 680 FICO to get a better rate and another tell you 700. 
2. "Does your company offer any discounts?" There are lenders that offer a lower rate if you can show retirement savings, have a co-signer, or for having the lender pay off your creditors directly if you take out a debt consolidation loan. Don't rely on the loan officer telling you about the discounts.

Be Strategic: Avoid personal loan mistakes

How you manage debt is an important part of your overall financial health. If you take on debt, be strategic. Weigh the benefits of what the personal loan money will do for you against the costs of paying back the principal and the interest.

Also think about the opportunity costs, what you are giving up by reducing your monthly cash flow to pay for the loan. This doesn't apply to a debt consolidation loan that saves you money, but taking out a loan to pay for a wedding, vacation, or other purchase that adds value to your life but isn't necessary leaves you with less money each month to put towards retirement, investments, building an emergency fund, or spending on smaller discretionary expenses.

If you take on debt without a well-formed plan, instead of advancing your interests, a personal loan can create financial problems. Avoiding easy to make mistakes is one way to protect yourself from unnecessary financial harm.