How to Avoid the 12 Most Common Loan Application Mistakes
How to Avoid the 12 Most Common Loan Application Mistakes
Applying for a loan can be a stressful and complicated process, especially if you are not familiar with the requirements and options available. You may end up making some mistakes that can hurt your chances of getting approved, cost you more money, or damage your credit score. To help you avoid these pitfalls, here are the 12 most common loan application mistakes and how to avoid them.
1. Not checking your credit score
Your credit score is one of the most important factors that lenders consider when evaluating your loan application. It reflects your credit history, payment behavior, and debt level. A higher credit score means you are more likely to repay your loan on time and in full, while a lower credit score means you are more likely to default or miss payments. Therefore, you should check your credit score before applying for a loan to know where you stand and what kind of interest rate and terms you can expect. You can get a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) once a year at annualcreditreport.com. You can also use online tools or apps to check your credit score for free or for a fee.
2. Not checking your repayment capacity
Another important factor that lenders consider is your repayment capacity, which is your ability to afford the monthly payments of your loan based on your income and expenses. You should check your repayment capacity before applying for a loan to make sure you can comfortably handle the debt without compromising your other financial obligations and goals. You can use online calculators or formulas to estimate how much you can borrow and how much you can pay back each month. A general rule of thumb is that your total monthly debt payments (including your new loan) should not exceed 36% of your gross monthly income.
3. Making too many hard inquiries
When you apply for a loan, the lender will perform a hard inquiry on your credit report, which will temporarily lower your credit score by a few points. This is normal and expected, as it shows that you are actively seeking credit. However, if you make too many hard inquiries within a short period of time, it can hurt your credit score significantly and signal to lenders that you are desperate for money or have trouble managing your finances. Therefore, you should avoid applying for multiple loans at once or shopping around for too long. Instead, you should do some research beforehand and narrow down your options to a few lenders that offer the best rates and terms for your situation. You should also try to apply for loans within a 14- to 45-day window (depending on the scoring model used), as multiple inquiries for the same type of loan within this period will be counted as one inquiry for scoring purposes.
4. Not evaluating different offers from different lenders
While you should avoid making too many hard inquiries, you should also not settle for the first offer you receive from a lender. Different lenders may have different criteria, rates, fees, and terms for their loans, and some may offer better deals than others depending on your credit profile and needs. Therefore, you should compare different offers from different lenders before choosing one that suits you best. You should look at the annual percentage rate (APR), which is the total cost of borrowing expressed as a yearly percentage; the loan amount, which is the amount of money you borrow; the loan term, which is the length of time you have to repay the loan; the monthly payment, which is the amount of money you have to pay each month; and any other fees or charges that may apply, such as origination fees, prepayment penalties, late fees, etc.
5. Not disclosing existing loan details
When you apply for a loan, you have to provide some information about your existing loans, such as their balances, interest rates, monthly payments, etc. This is because lenders want to know how much debt you already have and how well you are managing it. If you fail to disclose or lie about your existing loan details, it can backfire on you in several ways. First, it can damage your credibility and trustworthiness with the lender, as they can easily verify your information through your credit report or other sources. Second, it can affect your repayment capacity and loan eligibility, as the lender may not be able to accurately assess your debt-to-income ratio and offer you a loan that you can afford. Third, it can lead to legal consequences, as you may be accused of fraud or breach of contract if you default on your loan.
6. Not skimming through the fine print
Before you sign the loan agreement, you should read and understand the fine print, which contains the details and conditions of your loan. The fine print may include important information such as the APR, the loan amount, the loan term, the monthly payment, the fees and charges, the prepayment options, the late payment penalties, the default consequences, the dispute resolution procedures, etc. If you do not skim through the fine print, you may miss some crucial details that can affect your rights and obligations as a borrower. You may also agree to something that you are not comfortable with or that is unfavorable to you. Therefore, you should always skim through the fine print and ask questions or seek clarification if anything is unclear or confusing.
7. Opting for a longer term
When you apply for a loan, you have to choose a term, which is the period of time you have to repay the loan. The term can range from a few months to several years, depending on the type and amount of the loan. While opting for a longer term may seem appealing, as it can lower your monthly payment and make it easier to fit into your budget, it can also have some drawbacks. First, it can increase your total interest cost, as you will pay more interest over a longer period of time. Second, it can increase your risk of default, as you will be exposed to more uncertainties and changes in your financial situation over a longer period of time. Third, it can delay your financial goals, as you will have less money available for saving or investing over a longer period of time.
8. Borrowing more than you need
When you apply for a loan, you have to decide how much money you need and want to borrow. While borrowing more than you need may seem tempting, as it can give you some extra cash for other purposes or emergencies, it can also have some disadvantages. First, it can increase your debt burden, as you will have to repay more money with interest over time. Second, it can reduce your repayment capacity, as you will have to allocate more money for your loan payment each month. Third, it can affect your credit score, as it will increase your credit utilization ratio (the percentage of available credit that you use), which is a factor that influences your credit score.
9. Borrowing less than you need
On the other hand, borrowing less than you need may also be a mistake, as it can leave you short of funds for your intended purpose or emergency. If you borrow less than you need, you may have to resort to other sources of financing to cover the gap, such as credit cards or payday loans. These sources may have higher interest rates and fees than your original loan, which can increase your overall borrowing cost and debt burden. Alternatively, you may have to postpone or cancel your intended purpose or emergency altogether, which can have negative consequences for your personal or professional life.
10. Not having a clear purpose
When you apply for a loan, you should have a clear purpose for why you need and want to borrow money. Having a clear purpose can help you determine how much money you need and want to borrow; how long you need and want to borrow it for; how much interest rate and fees you are willing to pay; and how confident and committed you are to repay it on time and in full. Having a clear purpose can also help you avoid unnecessary or impulsive borrowing that can lead to overspending or debt accumulation.
11. Not having a repayment plan
When you apply for a loan, you should also have a repayment plan for how you will repay it on time and in full. Having a repayment plan can help you budget your income and expenses; set aside money for your loan payment each month; track your progress and balance; and avoid missing or late payments that can incur penalties or damage your credit score. Having a repayment plan can also help you pay off your loan faster and save on interest by making extra payments or paying more than the minimum amount each month.
12. Not considering alternative options
Before applying for a loan, you should also consider alternative options that may be available to meet your financial needs or goals without borrowing money or with less borrowing money. Some alternative options may include saving up money; selling some assets; asking for help from family or friends; applying for grants or scholarships; negotiating with creditors or service providers; etc.