Five Warning Signs Your Personal Loan Is a Bad Deal
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Personal loans can be useful tools. You can use them to pay off credit card debt, swapping those high interest rates for the lower ones that you'll typically nab with a personal loan. You can also use personal loans to fund a needed but expensive car repair or to cover the cost of remodeling your kitchen or bathroom.
Be careful when applying for these loans, though. Not every personal loan is a good deal. Some come with high interest rates or steep penalties. Other lenders charge exorbitant fees.
What warning signs should you look for when applying for personal loans? Here are five. You can spare yourself plenty of financial pain by avoiding these potential traps.
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Five warnings signs your personal loan is a bad deal
1. The interest rate is too high
If you are applying for a personal loan to pay off high-interest-rate credit card debt, you’ll need one that comes with a lower interest rate. But is a lender charging you a rate of 18%, 20%, or higher? That personal loan might not be worth taking out.
The Federal Reserve reported that in July of 2024, the average interest rate on a personal loan with a 24-month term was 12.36%. When you apply for a personal loan, you’ll want an interest rate near that mark.
A rate that low means that taking out a personal loan and using the funds from it to pay off credit card debt makes financial sense. The Federal Reserve said that the average interest rate on all credit card accounts in the United States stood at 22.76% in May of 2024. That’s significantly higher than the average rate attached to personal loans during the same time.
When you use a personal loan to pay off credit card debt, the goal is to swap a high interest rate with a lower one. If your lender is charging you interest closer to 20%? That’s not a good deal. Payday loans or cash advance loans have an exorbitant interest rate which is why it is best avoided as long as you have the creditworthiness to apply for a personal loan.
Be aware that lenders will charge you a higher interest rate if have bad credit. The higher your credit score, the lower your personal loan’s interest rate should be. If you have excellent credit, you will enjoy lower interest rates. Pay your monthly bills on time and pay off as much credit card debt as possible if you want to build strong credit history.
2. Your lender is charging exorbitant fees
It’s not unusual for legitimate lenders to charge origination fees when closing your personal loan. Make sure, though, that your lender isn’t charging excessive fees.
Credit bureau Experian says that personal loan origination fees average 1% to 8% of your borrowing amount. If you are borrowing $20,000, then, you can expect to pay from $200 to $1,600 in origination fees.
You can usually pay your origination fees upfront when closing your loan or roll them into your total loan amount. This later option will spare you the hassle of coming up with $1,000 or more at closing but will also increase the total amount you are borrowing and must pay back.
Make sure your lender discloses any origination or application fees upfront. You don’t want to be surprised with a big fee when you close the loan. Look carefully, too, for any hidden fees. Some lenders might charge an application fee or processing fee in addition to or instead of an origination fee. The key is to know exactly what you’ll be paying to close your loan.
Be careful when a lender claims that it charges no fees. That lender might mean it doesn’t charge upfront fees but rolls origination fees into your loan’s balance.
Fortunately, the Truth in Lending Act states that lenders must disclose all their fees. If your lender charges excessive fees – higher than 8% – steer clear. It’s time to shop for a personal loan that costs less.
Use Bankrate to Get a Personal Loan
- Get as much as $100,000 with rates starting at 5.95% APR*
- Use a personal loan to pay off debt, renovate your home, family needs, and more
- Takes minutes to see how much you can get
- Doesn't hurt your credit score to check
3. Your lender is charging a prepayment penalty
Some lenders charge prepayment penalties. These kick in when you pay off a loan’s balance too early. For instance, your lender might charge you a fee if you pay off your 24-month personal loan in six months or less.
Some lenders charge these to cover the loss of interest they would have earned if you took longer to pay off your loan. These fees vary and can be a flat rate or a percentage of your loan amount. Your lender might charge you $100 if you pay off your loan within six months or 0.5% of your outstanding balance if you pay off your debt before a year passes.
Either way, prepayment penalties are a bad deal. Finding a lender that won’t charge you for paying off a loan early is easy. Work with one of these lenders. And make sure to ask lenders if they charge these penalties.
4. Excessive late fees
If you pay late, your lender will typically assess a late fee against you. This is normal. What isn’t normal are late fees that are excessively high.
Experian says the average late fee on personal loans ranges from $25 to $50. Other lenders might charge a percentage of your monthly payment amount, usually 3% to 5%.
If a lender charges more than these figures? Look elsewhere. Consider credit unions, they often have favourable terms and charge no late fees.
Be aware, too, of your lender’s late penalty policy. Your lender might not charge you a late fee until your payment is two weeks late.
Prosper, a financial services provider that originates personal loans charges a late fee of $15 or 5% of your unpaid monthly payment amount, whichever is higher. Prosper charges this fee if you don't pay the full amount of your monthly payment within 15 calendar days after your payment due date. Upstart also charges a late payment fee of $15 or 5% of your monthly past-due amount, whichever is greater. But Upstart will charge this fee if you don't pay the full amount of your monthly payment within 10 calendar days of its due date.
Make sure you understand both the amount that your lender will charge if you make a late payment and when your lender will consider your payment officially late. If a lender is charging a late fee of more than $50? You might consider looking for another lending source.
5. Your lender charges annual or payment processing fees
There are two fees that your lender should never charge for a personal loan: annual and payment processing fees.
An annual fee is one that lenders charge once every year as you are paying off your personal loan. Lenders charge these fees to cover the costs of collecting and processing payments. Typically, an annual fee would be $100 or less.
Most lenders don’t charge annual fees for personal loans. It’s not difficult to find a lender who won’t charge you this fee. Shop around and avoid any personal loan that comes with an annual fee.
It’s uncommon, but some lenders charge a payment processing fee depending on how you pay your bill. Some will charge this fee monthly if you don’t sign up for automatic payments. Others might charge a fee if you send a check by mail each month instead of making your payments online. This payment processing fee varies but could run $15 a month.
Again, though, it’s easy to avoid this fee. Most lenders don’t levy payment processing charges. And even those that do typically only charge it when you pay by check instead of online. Make sure to work with a lender who won’t charge you anything for your favored way of paying. And if a lender insists on charging this fee no matter how you pay? Don’t apply for a loan with that company.
Related: What Can I Pawn to Make Money?
Pros & Cons
Pros
- Fixed interest rates. Many personal loans come with fixed interest rates, which means your monthly payments will remain the same throughout the loan term.
- Flexible use. Personal loans can be used for a variety of purposes and can help you handle any financial situation, including debt consolidation, home improvements, medical expenses, or major purchases.
- Lower interest rates compared to credit cards. Personal loans often have lower interest rates than credit cards, especially if you have good credit. This can save you money on interest payments if you’re using the loan to consolidate high-interest debt.
- Predictable repayment schedule. With fixed repayment terms, you know exactly when the loan will be paid off, which can help you plan your installments more effectively.
- Improves credit mix. Adding a personal loan to your credit portfolio can improve your credit mix, which can positively impact your credit score, provided you make timely payments.
Cons
- Fees and penalties. Personal loans can come with various fees, such as origination fees, late payment fees, and prepayment penalties. These fees can increase the overall cost of the loan.
- High interest rates for poor credit. If you have a low credit score, you may be offered a personal loan with a high interest rate, which can make the loan expensive and difficult to repay.
- Impact on credit score. Applying for a personal loan results in a hard inquiry on your credit report, which can temporarily lower your credit score. Additionally, missing payments can significantly harm your credit score.
Use Bankrate to Get a Personal Loan
- Get as much as $100,000 with rates starting at 5.95% APR*
- Use a personal loan to pay off debt, renovate your home, family needs, and more
- Takes minutes to see how much you can get
- Doesn't hurt your credit score to check
FAQs
Why is pressure from the lender to accept the loan quickly a red flag?
If a lender is pressuring you to accept the loan quickly without giving you adequate time to review and understand the terms, it could be a sign they are trying to prevent you from noticing unfavorable conditions. A reputable lender will allow you to take your time and make an informed decision.
How can I ensure I'm getting a good personal loan deal?
To ensure you’re getting a good deal, compare loan offers from various lenders, read reviews, and check the lender’s reputation. Carefully read the loan terms and conditions, and use loan calculators to understand the total cost of the loan over its term. Additionally, consult with a financial advisor if you need help understanding the loan terms.
How can high-interest rates indicate a bad loan deal?
High-interest rates significantly increase the total cost of the loan, making it more expensive to repay. If the interest rate is much higher than what other lenders are offering or the average rate for similar loans, it’s a red flag that the loan may be a bad deal.
The bottom line
You’ll pay enough in interest when taking out a personal loan. Don’t boost the cost of your loan even higher by working with lenders that charge unneeded or excessive fees. When you’re ready to apply for a personal loan, shop around for lenders that charge minimal or no fees and avoid falling into the trap of too much debt. And always make sure that your lender provides the entire cost of your loan in writing.
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Writer
Dan Rafter is a freelance writer who has more than 20 years experience covering personal finance. He's written for the Chicago Tribune, Washington Post, Bankrate, CreditCards.com, Rocket Mortgage, NortonLifeLock and several others.
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