Written by: Contributor | Best Company Editorial Team
Last Updated: April 13th, 2020
Ever since the financial crisis of 2008, the personal loans industry has become increasingly competitive. Over the past seven years, hundreds of personal loans companies (both local and online) have sprouted up in hopes of providing individuals of all credit scores with the loans that banks no longer provide. And while these businesses offer a number of different options, contract lengths, and approval times, there's only one number that consumers really seem to care about:
the interest rate.
We polled over 1,000 people on what they felt to be the most important quality of a personal loan, and the results are overwhelmingly in favor of interest rates. Meanwhile, other qualities such as approval time and fund availability, maximum loan amount, maximum term length, minimum FICO score required, and the number of states a particular company serves all pulled in under 10% of the vote each:
While the fact that this survey has been greatly skewed towards interest rates isn't shocking, it does reveal some important insights into the mentality of the average borrow. On the flip-side, it also demonstrates how personal loans companies can use this "interest rate myopia" to blindsight borrowers with hidden fees and other additional costs.
Why this Is Not Surprising
This statistic isn't necessarily surprising. When you think about it, interest can be just as (if not more) important that the principle amount of your loan; if left unattended, interest accrued on your loan can quickly get out of control - especially if your interest accrues on a daily basis. And while interest rates on personal loans can be much lower than interest rates on credit cards (and are usually fixed) not all interest rates are created equal - even among personal loans companies. Personal loans are usually "unsecured loans" meaning they don't require some kind of collateral, so the way the lenders make money on their loans is through interest, the rate of which is greatly dependent upon your credit score. Your credit score creates a wide-swinging door on potential interest rates; people with great credit can pay as low as three or four percent, while people with poor credit could be paying upwards of 30% in interest.
In short, interest rates can sometimes be the difference maker between whether you pay off your loan on time, or whether you're steeped in debt long after the terms of your loan have expired.
Why We May Need to Shift Our Focus
Yes, interest rates are incredibly important; but the overwhelming focus on a personal loans company's interest rates could lead consumers to ignore other important issues surrounding the personal loans industry. And just because a company offers the lowest interest rate does not necessarily mean it is the best company for your needs. Here are a few reasons why interest rates shouldn't be the only thing to consider before you sign the dotted line:
The Prepayment Penalty
As you review the terms of your personal loan, you should be on the lookout for the word "prepayment" before signing your name. The fact of the matter is, in order for lenders to make money they charge interest on their loans. When you sign to specific terms and length of contract, the lender expects to make a certain, calculated amount in interest off your payments. If you want to pay less in interest, you will try to pay off your loan as soon as possible. A prepayment penalty can be enforced when you pay off your loan before the length of the contract has expired. In other words, some personal loans companies can actually punish you for paying off a loan quickly.
Some personal loans companies may also try to throw in additional life or unemployment insurance policies as your loan negotiations come to a close. Often, they may try to pressure you into signing up by advertising low premiums; however, insurance can be especially tricky, especially when you weren't expecting to purchase any. Before you say "yes" to their sales pitch, you might ask exactly how much money this insurance will cost you each month, and more importantly under what conditions do you qualify for payment on a claim. Sometimes these requirements can be incredibly specific or complex, and you may find that an additional insurance policy costs more than it's worth.
While there's no avoiding origination fees, there are ways to prepare for them. Many times, the origination fee is hidden in the cost of the loan. For example, if you take out a $10,000 loan with a 3% origination fee, what you're actually doing is taking out $9,700 fee with a $300 origination fee attached. In order to make sure you're getting the full proceeds of your loan, make sure you're tacking on that additional 3% or whatever other percent the origination fee runs at. Often, this fee will be refunded when you have finished paying off the loan. In some ways, the origination fee works similar to a prepayment penalty in the sense that unless you adhere specifically to the terms and length of the contact, you could be stuck paying more than you intended.
In conclusion, interest rates are supremely important - but they're not the only thing you as a borrower should be aware of. In fact, applying for and paying off a personal loan can be a lot more complicated than you might think. There is a whole world of terminology and jargon the lender and paperwork will employ that you need to be ready for. Additionally, there are some questions you will need to answer before you decide to take out a loan. Remember, interest rates, while significant, are only one part of the entire personal loans process. If you become too fixated on that one area, you might be surprised to find that you're paying for more than just the interest rate.