Published in: Personal Loans | Sept. 30, 2019

The Worst Mistakes You Can Make When Taking Out a Loan

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Thinking about borrowing? Here are some mistakes you absolutely can't afford to make. 

Most of us have to borrow money at some point, whether that's taking out student loans to pay for school, an auto loan to buy a car, or a mortgage to purchase a home.

Borrowing can help improve your financial situation if you do it responsibly. Good loans help you grow your net worth and build credit. But they can also be bad news if you make borrowing mistakes. In fact, some errors you make when taking out a loan could devastate your financial security for years to come.

Young woman looking at computer screen from behind desk and pressing her hands to her face as if gasping in horror.

Image source: Getty Images

If you take out a loan, you don't want it to have an adverse impact on your financial life. Be absolutely certain you avoid these three borrowing mistakes. 

1. Borrowing money you cannot afford to pay back

If you aren't 100% sure you can make payments on a loan you're thinking of taking out, just say no to borrowing. Don't assume your income will increase or that you'll figure it out later. This could lead to complete financial disaster. 

Missing even one payment could damage your credit score for many years to come. That could make every loan you take out more costly or prevent you from getting the credit you need. And defaulting on a loan could lead a creditor to pursue collections efforts. They might sue you and garnish your wages or get a lien put on your property. 

If you've taken a mortgage or a car loan, foreclosure or repossession could also happen and you could lose the money put into your home or vehicle. Your credit could be damaged for a decade, too.

Always look at your budget before borrowing and make 100% sure that your new loan payment is comfortably affordable. If you have even a shadow of a doubt about whether you'll be able to make payments on the loan during the entire time you're borrowing, don't take out the loan.

2. Borrowing money at too high of an interest rate

The higher your interest rate, the higher the cost of borrowing and the harder it is to repay your loan. That's because more of your money will go towards interest so your principal balance will decline slowly. 

You're also committing to a big financial obligation, which could make it harder for you to live on a budget or accomplish other financial goals. Borrowing at a high rate also cuts off your options in the future. You might not be able to switch to a job you'd prefer if you'd have to take a pay cut, for example. 

Since getting the lowest interest rate possible is so important, shop around and get quotes from multiple lenders before you borrow. It's worth the effort to look carefully at different loan terms and compare rates from at least three lenders. You never know when one loan provider may offer significant savings compared with its competitors. 

3. Taking out a loan you don't fully understand

When you borrow, you need to know

  • the monthly payment;
  • whether your payment could go up, how often it could go up, and what could trigger its rise;
  • what your maximum payment amount would be if your payment went up;
  • when you're expected to repay your loan in full;
  • the total amount of interest you'll pay over the life of the loan; and
  • whether you're subject to prepayment fees or penalties if you pay off the loan early or refinance it.

If you don't fully understand the terms of your loan, you could end up with a variable rate loan that becomes unaffordable down the road or a loan that requires a big lump sum payment. Or you could end up stuck in a loan that you can't really afford and can't get out of. And this could lead to financial disaster.

Many people ended up with mortgages they didn't understand in the lead-up to the 2008 financial crisis, and millions ended up in foreclosure or almost lost their homes because of it. While this is an especially big problem with mortgage loans, you should know the details of any borrowing you do -- even if you're just signing up for a credit card.

If you understand your loan you can make an informed choice about whether it's affordable and a wise financial move.

Avoiding these mistakes is key to financial success

If you can avoid these borrowing mistakes, you should be able to stay out of serious debt trouble. Your debt should be a tool that helps you do things rather than an albatross around your neck that makes money management impossible.

Our Picks of the Best Personal Loans for 2019

We've vetted the market to bring you our shortlist of the best personal loan providers. Whether you're looking to pay off debt faster by slashing your interest rate or needing some extra money to tackle a big purchase, these best-in-class picks can help you reach your financial goals. Click here to get the full rundown on our top picks.