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Borrowing to squash your debts? This move could help you save


If you’re thinking of tidying up your balance sheet by taking out a personal loan, consider doing some research first.

It could save you thousands of dollars.

That’s because the interest rates lenders charge on personal loans can vary significantly, even if you have pristine credit, according to an analysis by LendingTree, a loan comparison site.

The website studied three-year personal loans offered to borrowers with credit scores of at least 640.

Personal loans are unsecured debts with a typical term of three to five years. They generally charge a fixed interest rate.

Borrowers take them out for several reasons, including debt consolidation, home improvements and wedding finances.

Rates on personal loans can run as low as 5.95% to as high as 35.89%, according to Bankrate.com.

Here’s the catch: While borrowers with higher credit scores generally are eligible for lower interest rates, even those with pristine credit can see significant differences in offered rates.

That means it pays to shop around.

For instance, the average annual percentage rate, or APR, on a personal loan for these top-tier customers was 9.92%, yet lenders were willing to offer the top 10% of these borrowers an average APR of 5.43%, according to LendingTree.

The difference was also stark when it came to borrowers in a lower tier — those with credit scores between 640 and 679.

The average best APR offered here was 24.9%, while lenders were willing to charge as little as 12.34% to the top 10% of these customers, LendingTree found.

“That’s an interesting trend, the variability in offers you get even with high credit,” said Michael Funderburk, general manager of personal loans at LendingTree.

Here’s what’s driving those differences.

Unsecured debt

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Unlike car loans or mortgages, personal loans don’t have any collateral backing them. This makes them riskier for the lender, resulting in higher rates based on your creditworthiness.

Further, lenders can charge lower or higher rates depending on their own capital cost structure and operating expenses, said Funderburk.

“Some lenders are traditional companies with brick and mortar stores, and they tend to have higher overhead,” he said.

On the other hand, newer lenders may operate exclusively online, have lower expenses and may be better able to offer a more attractive rate.

Overall, more people are taking out personal loans.

During the second quarter of the year, total personal loan balances hit $148.4 billion, up 18.4% year over year, according to data from TransUnion.

The average new account balance has hit a record high of $6,790, Transunion found.

Getting the lowest rate

Regardless of where your credit score stands, it pays to shop around for a personal loan and to borrow responsibly.

“Before you do anything, it’s important to understand the financial condition you’re in,” said Funderburk.

Clean up your records. Before you shop for offers, tidy up your credit report. Make sure that you don’t have any glaring issues with your data. “Be sure there isn’t anything on your credit profile that’s just an error that you can dispute,” said Funderburk.

Ask about discounts on APR. Lenders might be willing to trim your rate by 25 to 50 basis points (that is, 0.25% to 0.50%) if you schedule automatic repayments on the loan, Funderburk said.

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If you’re using the loan to squash a debt, your personal loan provider might also offer an APR discount if you allow them to directly pay the current loan obligation.

Only borrow what you can afford. Be sure you can swing the monthly payment on the personal loan. Consider the “back-end ratio,” a rule of thumb that says your monthly housing costs and debt payments should not exceed 36% of your gross monthly income.

Borrow for the right reasons. Using a personal loan to reduce credit card debt can be a responsible move — if you commit to changing your ways. Make sure you don’t continue borrowing and spending irresponsibly.

Know your fees. Borrowing costs money. Ask about origination fees and prepayment penalties. “Origination fees associated with loans can range considerably from 0 to hundreds of dollars,” said Funderburk.

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