How to Compare Personal Loans

Here are some tips on shopping for personal loans so you don't make the mistake of comparing apples to oranges.

Comparison-shopping for the best personal loan may not be fun, but it's certainly worth your time. Consider that over the full term of a three-year loan, even a $10 difference in monthly payments adds up to $360 -- no small amount of money.

Below I'll show you the best way to compare personal loans, as well as some tricks you can use to get the best rate on your next loan.

How to compare personal loans the right way

When it comes to comparing personal loans, the annual percentage rate (APR) on the loan is what matters most. The APR is a percentage that reflects how much a loan costs on an annual basis, including interest and applicable fees. The interest rate alone doesn't tell the whole story, so APR is the best way to compare two loans on an apples-to-apples basis.

Consider the two loans below. The first carries an interest rate of 8% without origination fees. The second loan has an interest rate of 6% and carries a $200 origination fee (4% of the starting loan balance).

Source: Author.

Which loan is a better deal? Well, it's not exactly clear...yet.

The only way to compare these two loans is to look at the APR on each. In the United States, lenders are required to provide an APR when making a loan offer.

In this case, the first loan would have an APR of 8%, because there are no other costs aside from the interest you pay. The APR for a no-fee loan should be very close to the interest rate, with perhaps only a slight difference (if any) due to rounding.

The second loan has a lower interest rate, but the origination fee makes it costlier than it may appear at first glance. Loan B has an APR of 8.65% -- higher than the interest rate of 6%, because the APR includes the $200 origination fee as a cost of the loan.

Think about it this way: Loan B will require you to make payments as if it were a $5,200 loan ($5,000 principal plus $200 origination fee) at 6% interest. A $5,200 loan at 6% and a $5,000 loan at 8.65% carry the same monthly payment for three years ($158.19).

In short, a loan's APR gives you a figure that you can directly compare to another loan, because it takes all the costs of the loan into consideration.

Getting the best deal on a personal loan

The personal loan market is as competitive as it has ever been. Thanks to the internet, borrowers can get a quote from several different lenders in a matter of minutes, whereas getting quotes from multiple offline banks would take a whole day of driving from branch to branch.

There are a few things you should know about shopping for the best loan terms:

1. You won't hurt your credit score. The best online personal loan providers now enable borrowers to get a quote for a loan with a soft credit check. That means you can get quotes from 20 different lenders without getting a hard inquiry on your credit report, which in turn means your credit score won't take a hit. Only when you accept a loan will a lender do a hard pull of your credit for verification purposes.

2. Repayment terms matter. The longer you take to repay a loan, the higher the APR will be. A shorter loan term lowers your APR by reducing the amount of interest that accrues on your balance.

3. A cosigner may help. Some personal loan companies allow you to have a cosigner when getting a loan. If you have bad credit, a cosigner can make a big difference in the rate you receive, but finding a cosigner won't be a walk in the park. If you fail to make payments, the cosigner is legally responsible for the balance.

4. Some lenders have special deals. Some companies offer lower APRs to borrowers who meet certain criteria. For example, some of the best personal lenders offer a rate discount to people who have good credit scores or who agree to set up automatic loan payments from their checking accounts.

5. Paying down small card balances can help. If you have any small debts, paying them off before you apply for a personal loan may help you qualify for a bigger loan or a lower APR. Lenders can figure out how much you owe on other debts each month from your credit report, which they can use to determine how capable you are of making payments on a personal loan. If you have a handful of low balances, eliminating them before applying for a personal loan could be advantageous.

Realistically, your ability to get a lower rate on a personal loan is limited only by your willingness to shop around. Of course, it's probably not worth applying for 100 different loans just to shave 0.1% off your APR. Getting a quote from three different lenders, however, will give you some idea of what you can expect to pay for a loan and what sort of APR you're likely to get.

The skinny on personal loans

Personal loans can be used for just about everything, but they're most practical when they're used to consolidate high-interest debt. For example, using a personal loan with an 8% APR to refinance $5,000 of credit card debt at an 18% APR can save you nearly $867 in interest over a three-year repayment period. That's some serious savings!

Personal loans can also be used for consumption. You can use them to pay for moving expenses, home improvements, or a vacation. It goes without saying, though, that using a personal loan for "wants," rather than "needs," can be costly. Using a $3,500 personal loan to pay for a vacation of your dreams may be fun, but making monthly payments of $110 or more for the next three years certainly won't be.

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