For most people, personal loans can provide an affordable alternative to credit cards and help you finance different projects or purchases while saving on interest.
Increasingly, personal loans are growing in popularity, with roughly 21.7 million borrowers in Kenya in Q1 2021 according to a TransUnion financial report.
Whether you are looking to take out a personal loan to consolidate debt, finance a project, start a business, etc, it is important to have a clear repayment plan.
Below are 10 questions you should ask yourself to make sure you are well prepared for a personal loan.
1. How much do I need?
The first step in choosing a personal loan is knowing how much you need. The smallest personal loan sizes begin at around Ksh. 50,000, but most lenders offer a minimum of Ksh. 100,000 to Ksh. 200,000. If you need less than half a million shillings, it might be easier to save up extra cash in advance, or borrow the money from a friend or family member if you are in a pinch.
2. Does the personal loan have fees?
Personal loan lenders may charge a sign-up, or origination, fee, but most don’t charge any fees other than interest.
An origination fee is a one-time upfront charge that your lender subtracts from your loan to pay for administration and processing costs. It is usually between 1% and 5%, but sometimes it’s charged as a flat-rate fee. For example, if you took out a loan for Ksh. 10,000 and there was a 5% origination fee, you would only receive Ksh. 9,500 and Ksh. 500 would go back to your lender. It is best to avoid processing fees if possible.
3. Do I have a good credit score?
Before you start applying for personal loans, it is important to know your credit score to make sure you can qualify. Most personal loan lenders are looking for applicants to have a good credit score, particularly online banks. However, if you have an existing relationship with a bank, you may get approved for a favorable deal if you have a good history of paying bills on time and honoring the terms of your past loans and accounts.
Sometimes, SACCOs will offer lower interest rates on personal loans and work with borrowers who have fair or average credit scores. But you often need to become a member and save for a while before you can qualify for a loan.
4. What is the mode of repayment?
When you take out a personal loan, the cash is usually delivered directly to your checking account. But if you are using a loan for debt consolidation, a few lenders offer the option to send the funds directly to your other creditors and skip your bank account altogether.
If you prefer a hands-on approach or are using the money for something other than paying off existing debt, have the funds wired to your checking account.
5. How long will I have to pay it back?
You will have to begin paying the loan company back in monthly installments within 30 days. Most lenders provide repayment terms between six months and seven years. Both your interest rate and monthly payment will be impacted by the length of the loan you choose.
6. How much will I pay in interest?
Your interest rate depends on a number of factors, including your credit score, loan amount and your term (length of time you’ll be paying the loan back). Interest rates can be as low as 8% and as high as 20% or more. Typically, you will get the lowest interest rate when you have a good or excellent credit score and you choose the shortest repayment term possible.
7. Can I afford the monthly payment?
When you apply for a personal loan, you have the opportunity to choose which repayment plan works best for your income level and cash flow.
Some people prefer to make their monthly payments as low as possible, so they choose to pay back their loan over several months or years. Others prefer to pay their loan off as quickly as possible, so they choose the highest monthly payment.
Choosing a low monthly payment and a long repayment term often comes with the highest interest rates. It might not seem like it because your monthly payments are so much smaller, but you actually end up paying more for the loan over its lifetime.
8. How soon do I need the funds?
Some personal loan lenders, especially mobile app lenders or telco lenders like M-Shwari deliver funds electronically on the same day if you are approved. Other lenders need up to 10 business days. If quick access to money is important for your situation, be sure to select lenders with fast delivery.
9. How will a personal loan affect my credit score?
Personal loans are a form of installment credit, whereas credit cards are considered revolving credit. Having both types of credit in your profile will strengthen your credit mix.
Having a diverse credit mix is helpful, but it is not everything. Some say that adding a new installment loan, like a car loan or a mortgage, can boost your score, but you do not have to take on debt unless you actually need it.
To maintain a good credit score, focus first on on-time payments and credit utilization.
While taking on an installment loan is not in itself going to boost your score a whole lot, using a personal loan to pay off revolving debt will cause the most noticeable increase in your credit score.
10. What other choices do I have?
If you are looking to pay off debt, balance transfer cards are another option.
A balance transfer card allows you to pay zero interest for up to two years, easily saving you hundreds of cash.
Depending on your situation, you may also be able to transfer more than one credit card balance to the new card as long as the total doesn’t exceed your credit limit.
However, balance transfer cards are increasingly difficult to qualify for as lenders are tightening their requirements for new credit. They also have other draw backs, including balance transfer limits (which is often lower than your actual card limit) and balance transfer fees.
Personal loans are a great option, but like any financial product, they are most beneficial when you have a plan. After carefully going through questions listed above, do a soft inquiry on the lender’s website or on a third-party lending marketplace so that you can see your options without hurting your credit score. After you see what you prequalify for, only then should you follow through with a hard inquiry.