For most people, personal loans can be an affordable alternative to credit cards and help you finance different projects or purchases while saving on interest.
Increasingly, personal loans are gaining popularity, with an estimated 21.7 million borrowers in Kenya in the first quarter of 2021 according to a financial report from TransUnion.
Whether you’re looking to take out a personal loan to consolidate debt, finance a project, start a business, etc., it’s important to have a clear repayment plan.
Below are 10 questions you should ask yourself to make sure you’re well prepared for a personal loan.
1. How much do I need?
The first step in choosing a personal loan is knowing the amount you need. Smaller personal loan amounts start 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 may be easier to save money up front or borrow money from a friend or member of the community. family if you are in a hurry.
2. Are there any fees for the personal loan?
Personal lenders may charge a listing or original fee, but most don’t charge any fees other than interest.
The origination fee is a one-time upfront fee that your lender subtracts from your loan to pay for administration and processing fees. It is usually between 1% and 5%, but sometimes it is billed as a flat rate. For example, if you took out a loan for Ksh. 10,000 and there was a 5% creation 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 rating?
Before you start applying for a personal loan, it’s important to know your credit score to make sure you qualify. Most personal lenders are looking for applicants with good credit, especially online banks. However, if you already have a relationship with a bank, you can get approval for a favorable deal if you have a habit of paying your bills on time and honoring the terms of your previous 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 have to become a member and save for a period of time before you can qualify for a loan.
4. What is the reimbursement method?
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, some lenders offer the option of sending the funds directly to your other creditors and skipping your bank account altogether.
If you prefer a hands-on approach or if you are using the money for something other than paying off existing debt, have the funds transferred to your checking account.
5. How long will I have to pay back?
You will need to start repaying the loan company in monthly installments within 30 days. Most lenders offer repayment terms between six months and seven years. Both your interest rate and your monthly payments 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 rating, the loan amount, and your term (how long you will pay off the loan). 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 rating and choose the shortest possible repayment term.
7. Can I afford the monthly payment?
When you apply for a personal loan, you have the flexibility to choose the repayment plan that best suits your income level and your cash flow.
Some people prefer to keep their monthly payments as low as possible, so they choose to pay off their loan over several months or years. Others prefer to repay their loan as quickly as possible and therefore choose the highest monthly payment.
Choosing a low monthly payment and a long repayment term often comes with the highest interest rates. It may not sound like it because your monthly payments are much smaller, but you 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 telecom lenders like M-Shwari, provide funds electronically the same day if you are approved. Other lenders need up to 10 business days. If quick access to cash is important to your situation, be sure to select lenders that offer quick delivery.
9. How will a personal loan affect my credit rating?
Personal loans are a form of installment credit, while credit cards are considered revolving credits. Having both types of credit in your profile will strengthen your credit mix.
Having a diverse credit mix helps, but that’s not all. Some say that adding a new installment loan, like a car loan or mortgage, can boost your score, but you don’t have to go into debt unless you really need to.
To maintain a good credit rating, focus on making payments on time and using credit first.
While taking out an installment loan doesn’t improve your score much, using a personal loan to pay off revolving debt will result in the most noticeable increase in your credit score.
10. What other choices do I have?
If you are looking to pay off your debts, 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 dollars.
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 does not exceed your credit limit.
However, it is increasingly difficult to qualify for balance transfer cards as lenders tighten their requirements for new credit. They also have other drawbacks, including balance transfer limits (which are often lower than your card’s actual 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 considering the questions listed above, conduct an informal survey of the lender’s website or a third-party loan marketplace so you can see your options without hurting your credit score. Once you have seen what you are prequalifying for, only then should you proceed with a thorough investigation.