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How to Manage Your Personal Loan Payments

| Money Rates Columnist
min read

family-paying-billsBut, getting a personal loan is about more than securing a loan approval.

 

  • How will you budget and manage your personal loan payments?
  • What steps can you take to pay on time to improve your credit history and score?
  • Does it make sense to refinance your personal loan or to pay it off early?

You have to think of a personal loan as one link in a financial chain which - with care - can lead to bigger loans, higher credit scores, and financing for homes and cars. Here's what you need to know to manage it wisely.

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Budget for Your Personal Loan Payment

If you've gotten a personal loan, there's much to celebrate. The money you wanted is now in your pocket. With a fixed-rate personal loan, you know how much you pay each month and when the loan will be paid off.

And make no mistake about it. If you've gotten a personal loan, if you've gone through the application process with a bank or credit union, then you have something to show for your good financial habits. It's a financial accomplishment and something of which to be proud.

Personal loans are installment loans. You normally make identical monthly payments at a fixed interest rate over a predetermined term. At the end of the loan term, you have repaid your loan and your balance is zero. This makes budgeting for them easier than loans with variable payments like credit cards.

You can see the challenge here. To maintain your credit standing - and to improve it - you need to make full and timely payments every month. There can be no exceptions. You have agreed to pay back lenders on a monthly basis and with interest. All lenders want is for you to keep up your part of the bargain. That means if you have a rough financial month, lenders don't really want excuses instead of money. What they want is to get their full check when it's due.

The requirement to repay a personal loan should be seen as an opportunity. It's a reason to set aside money for emergencies and surprise expenses.

Budgeting Should Include Savings

The reality is that millions of Americans do not have any real savings. If they run into a tough financial situation, if they work fewer hours or have a sudden expense, they don't have the means to deal with it. What do they do? In too many cases, they're forced to deal with a payday lender or an auto title lender, two types of financing with notoriously high rates and harsh terms.

According to the Federal Reserve, "relatively small, unexpected expenses, such as a car repair or replacing a broken appliance, can be a hardship for many families without adequate savings. When faced with a hypothetical expense of $400, 61 percent of adults in 2018 say they would cover it, using cash, savings, or a credit card paid off at the next statement."

The catch with the Federal Reserve statement is the 39% of the adults it interviewed did not have the reserves or credit cards to pay off something as small as a $400 expense.

The bottom line is this. To protect your finances you need to have a budget. You need to know how much you spend every day, every week, and every month. Once you have this information you can then look at your spending and see where it's possible to reduce costs. The money you save can be set aside in a savings account for emergencies.

50/30/20 Budget Planning

One common approach to budgeting is to have a 50/30/20 plan. Here's how it works if you have a gross household income of $8,000 per month. Take your gross monthly income and subtract all taxes. How much you deduct will depend on such matters as your tax situation and the state where you live. Let's say that taxes cost $1,200 per month. You now have your net monthly income, a total of $6,800 in this example. You take this amount and divide it into three categories.

  • 50% of your money - $3,400 -- is set aside for required spending. You need money for such things as food, utilities, housing, and transportation every month.
  • 30% of net income - $2,040 - can be devoted to wants, the things you like doing such as going to a restaurant or sporting event, hobbies, or guitar lessons.
  • 20% of your money - $1,360 - will be used for one of two purposes. Either paying down debt or setting aside for savings.

Follow a budget and you will quickly find an immediate benefit. You'll have cash on hand to pay all required monthly bills on time and in full. The result is that you will not have costly late fees plus your credit standing will improve. The money not spent on late fees can be added to your savings account.

Setting Up Your Personal Loan Payment

Different lenders have different ways to collect monthly payments. It's your responsibility to make sure that your required monthly payments arrive on time if not before.

It is very useful to set up a calendar that shows several dates.

First, when a bill is generally expected.

Second, the required payment date.

Third, there may be a payment grace period. The reason for grace period is that lenders don't want to argue about payment mechanics such as when a payment was received, did they not process it quickly enough and therefore you must pay a late fee, etc.

The general standard is this. To avoid payment issues it makes sense to pay bills on the day the invoice is received. This quickly settles the matter and assures you will not have a late payment.

When you receive a bill from a creditor, look at the invoice carefully. Many lenders are perfectly happy to accept extra principal payments. From their perspective, the faster a debt is paid down, the better. The perspective of the borrower is no different.

In today's electronic world, it is usually possible to pay with a credit or debit card, electronic transfer, paper check, or automated payments from a checking account.

Lenders really like automated payments because they're fast and easier to process. Often, you can get a discount if you will agree to automated payments, plus you don't have to worry about postage, envelopes, labels, and things getting lost in the mail.

If you elect to use automated payments, be certain to have overdraft protection on your checking account. This will protect you against costly overdraft fees. Overdraft protection is generally free or cheap and easy to get.

What Happens if You Miss a Loan Payment?

Missing a personal loan payment is not good, but at the same time it may not be 100% bad. As explained above, many loan programs have a grace period which will allow you to have a payment that arrives after the stated due date without penalty.

You have to look at the specific repayment requirements for each bill you have. In many cases - but not all - they will work like this if payment is due by the first of the month.

  • If the obligation has a 15-day grace period and you make your payment on the 10th then nothing happens. No harm no foul.
  • If the payment arrives on the 17th you will owe a late fee. Like the sizes vary but whatever their size they don't help borrowers. But even then, your credit report won't take a hit as long as you pay within 30 days of the due date.
  • If the payment arrives more than 30 days late, you're likely to see a negative item on your credit report. That negative item will push down your credit score. Some late payments, however, will not automatically result in a negative report. For example, medical bills will not show up on the credit report for six months, because their payment is often the responsibility of a third-party such as an insurance program.

If you know that an upcoming payment will be late, the smart strategy is to contact the lender and tell them what's going on and why. In return for your courtesy, a lender might be willing to waive the late fee and to not report the matter to credit reporting agencies. Why will lenders do this? Because if you have a generally good payment history, lenders will want to retain you as a customer.

Paying Off Your Personal Loan Early

It can make a lot of sense to repay a personal loan early. If you pay off your debt in advance, it means monthly cash costs will be smaller, your debt-to-income (DTI) ratio will decline, and the money you're not paying can be used for other costs or put into savings. The more extended your loan repayment term, the higher your interest cost.

When to Refinance Your Personal Loan

Refinancing a personal loan can be advantageous if you achieve one or more financial goals. For instance, if refinancing means a lower interest rate, a smaller monthly payment, a shorter loan term, or a switch from adjustable-rate financing to a fixed-rate loan, you can come out ahead.

You might also want to refinance to obtain more cash. If you have a $5,000 personal loan at 10% interest, and it becomes possible to borrow $7,500 at 9%, it might be something you want to look into, especially if you can refinance with your current lender and avoid excess fees and charges.

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