What to consider before applying for a personal loan

A personal loan can be a useful financial tool, but it’s also an obligation. It’s essential to understand what you’re agreeing to before you sign. 

Tip: A personal loan from a reputable provider can offer a cash boost when you need it most.

What is a personal loan?

A personal loan is granted to a consumer to meet a specific, once-off financial need, says Thabani Ndwandwe, chief risk officer at Standard Bank. The loan is repaid in instalments over an agreed period, or “term”.

Personal loans are considered to be unsecured debt, as you don’t have to put up any assets as security, such as a car or a house. Lenders base their approval solely on factors such as income, creditworthiness, and ability to repay.

Loan amounts can vary from as little as R1,000 to around R350,000, depending on the lender and your creditworthiness.

When can you apply for a personal loan?

Applying for a personal loan is a financial decision that requires careful consideration.

There are many uses for this form of borrowing, including, for example, financial relief in unforeseen circumstances, achieving major life goals such as further education, consolidating your debt at a lower interest rate, or increasing the value of your home via renovations or a solar installation.

However, you must consider whether the loan is for a “need” or a “want”, cautions Nozizwe Tshabuse, managing executive: client debt management and recoveries at Nedbank.

“If it’s for something non-essential, such as a vacation or a new cell phone, it doesn’t justify the monthly repayment obligation,” she says.

It’s never wise to use a personal loan for gambling, speculating on cryptocurrency or other investments, or purchasing luxury items. These actions can lead to unnecessary debt and financial instability.

Finally, be sure to check your credit score before applying. If your credit score is poor, you will likely pay higher interest rates.

What determines whether you qualify for a loan?  

Registered credit providers are legally obliged to adhere to the National Credit Act, which sets out minimum criteria to be considered when granting credit, says Ndwandwe.

“The criteria relate to a consumer’s credit history and their ability to afford the loan repayments,” he explains. 

The following factors are likely to come into play when your loan application is assessed.

Income and expenditure

These criteria determine whether you can afford a loan and the monthly repayments, says Ndwandwe. Lenders look for a stable, verifiable source of income, such as employment, investments, or government benefits. If you’re self-employed, bank statements, annual financial statements, and/or tax returns will be required. 

Credit score

Your credit score is a number that represents your creditworthiness, based on information in your credit report, such as amounts owing, the extent of your credit history, your credit mix, and credit enquiries on your report. 

Lenders will examine your past and existing repayment performance, Ndwandwe notes. If your bank is the lender, it will also check how you manage your transactional accounts.

Loan term

The period over which you agree to repay the loan can affect your ability to qualify for the loan, and the terms you receive. A longer loan term means lower monthly payments, but you’ll also pay more interest over the life of the loan. 

“Lenders may apply loan-term and loan-amount caps to protect consumers against interest rate hikes and unexpected expenditure that may occur after the credit facility has been agreed upon,” says Ndwandwe.

Debt-to-income ratio (DTI)

Your debt-to-income ratio is the proportion of your income that is used to repay your debt. Anton Schutte, financial planning and development manager at Exponential Financial Services, says lenders use this ratio to assess a borrower’s ability to manage debt repayments relative to their gross monthly income, to determine whether they’re eligible for a loan, and the loan amount they qualify for.

How to increase your chances of being approved for a loan

Follow these tips to improve your chances of getting a loan:

• Live within your means – your expenses should not exceed your income.
• Reduce your debt-to-income ratio – meaning, the proportion of your income that goes towards servicing your debt.
• Improve your credit score – read how below. 
• Shop around and compare terms and interest rates among personal loan providers. If you need to apply for a loan in order to source a quote, take care, as multiple loan applications can cause your credit score to drop.

Understand the purpose of the loan 

Knowing what you want the credit for will help you choose the type of loan you need. This helps you plan and budget more efficiently, so you don’t borrow more than necessary – thereby incurring additional interest charges and a higher debt burden.

The purpose of the loan can also affect the repayment period and loan structure. Terms can vary depending on the lender, loan amount, your creditworthiness, and other factors.

Understand the type of loan, and your lender’s expectations, before you apply.

Understand your credit score 

Understanding your credit score helps you to manage your finances more effectively. Let’s examine how this works.  

What is a credit score and why does it matter in the loan application process

Your credit score is an indication of your trustworthiness as a borrower. However, it’s not a static number – it’s a dynamic metric that changes with your financial behaviour.

By monitoring and improving your credit score, you can increase your borrowing power. Check your credit score regularly to ensure you’re on a sound financial track.

Credit providers use your credit score to assess how likely it is that you’ll be able to repay your debt. “Generally speaking, a higher credit score results in a higher likelihood of being granted credit and receiving favourable loan offerings,” says Ndwandwe.

This includes being able to negotiate beneficial interest rates and loan terms.

Tshabuse recommends checking your credit score and repayment history before applying for a personal loan. “Knowing the status of your credit health before you apply will determine whether you can use your existing credit score, or you need to work on improving it before applying,” she notes. 

Tips to improve your credit score before applying for a loan

You can maintain a good credit score – and improve it – by exercising financial discipline. This includes, for example, making timely payments, limiting your credit use, and understanding the link between how you manage your money and your credit score.

Simply being vigilant about your financial behaviour and regularly checking your credit report for errors can also assist.

Ndwandwe recommends the following steps to improve your credit score:

• Make timely repayments on your credit agreements, and don’t miss any payments.
• If you do miss a payment, catch up on overdue repayments as quickly as possible.
• Avoid exceeding your credit limit.
• Pay off existing credit agreements before entering new ones, thereby limiting the number of open credit agreements.
• Manage store accounts and credit cards responsibly. These products can be good entry points for building a credit score, but if you manage them irresponsibly, it can harm your score.

Assessing your financial health

Assessing your financial health helps you to understand your financial status and identify areas for improvement.

Having a good grasp of your income, expenses, and debt allows you to set realistic financial goals and budget accordingly, whether you want to save for retirement, buy a home, or pay off debt.

Schutte notes that it’s essential to know where your money goes. “[Knowing how you spend] allows you to allocate funds effectively, avoid overspending, and identify areas where spending can be reduced even if it is within budget.”

Understanding your debt will help you manage and reduce it, and prepare a repayment plan that fits your budget. You should also be able to set funds aside for emergencies, so you don’t have to rely on high-interest debt, such as a credit card.

Work with a financial planner to set and achieve goals, make informed decisions, and work toward financial security and peace of mind, Schutte recommends. “This will help to build a solid foundation for your future,” he explains.

It’s a good idea to review your financial plan at least annually.

How to determine the loan amount you can afford 

Your debt-to-income ratio compares your monthly debt repayments with your income.

Calculate the ratio as follows:

• Add up your total monthly debt repayments. Include credit cards, student loans, car loans, bond repayments, personal loans, and other debt obligations.
• Determine your gross monthly income. This is your total income before taxes and other deductions. Include income from all sources, such as your salary, bonuses, commissions, maintenance payments, and any other revenue.
• Divide your total monthly debt repayments by your gross monthly income, and multiply by 100 to calculate a percentage. The formula is: DTI = (total monthly debt payments ÷ gross monthly income) × 100

For example, if your total monthly debt repayments amount to R7,500 and your gross monthly income is R20,000, your DTI ratio will be: (R7,500 ÷ R20,000​) × 100 = 37.5%.

“Lenders use your DTI ratio to assess your ability to manage additional debt responsibly,” says Schutte. “The lower your DTI ratio, the better, as it indicates you have more income available to cover new debt payments.”

A DTI ratio below 36% is generally considered healthy, he adds; although specific thresholds may vary, depending on the lender and the type of loan.

“Once you know your DTI ratio, you can use it as a guideline to help determine how much you can afford to borrow for a personal loan,” Schutte points out.

Ensure you can manage your loan repayments

Managing loan repayments is crucial to avoid financial stress and protect your credit score.

Just because you qualify for credit doesn’t mean you should use it, especially if you can’t comfortably afford the instalments.

“Work out what you can afford to repay each month. You’ll find it hard to repay if you don’t have any spare cash,” Tshabuse says.

“Include extra charges and fees when checking affordability, since you’ll be charged a monthly administration fee and an initiation fee based on the size of your loan.”

Ndwandwe has some useful tips for managing loan repayments:

• Compare offers from multiple lenders to find the terms and rates that best suit your needs and circumstances. Wherever possible, avoid applying for a loan when seeking a quote, as multiple applications can affect your credit score.
• Avoid borrowing more than you need, and include repayment amounts in your budget.
• Load a debit order to run on your salary date to ensure payments are made timeously.
• Make extra payments if you’re able to do so.
• Proactively reach out to your credit providers if you expect challenges in honouring your loan repayments.

Choosing the right loan type

Ndwandwe notes that it’s important to choose the right loan type, as this will affect your costs, credit use, and borrowing outcomes.

Before applying, research loans catering to your specific borrowing needs. Select the most appropriate loan type to secure the best loan terms and repayment structure. 

To buy a second-hand car, for example, you may consider a personal loan at 25% interest, but it would be better to opt for a vehicle loan at 14% interest. A personal loan is unsecured, but a vehicle loan is secured as the bank has an asset it can liquidate if you’re unable to make your repayments – hence the lower interest rate. 

The type of loan you choose, and your ability to make timely payments, can also affect your credit score.

Different types of personal loans

Personal loans don't have any assets attached, which presents a list to the lender, so they tend to attract higher interest rates. 

Specific terms, eligibility criteria, and interest rates for personal loans vary from lender to lender.

Creditors can offer fixed-rate or variable-rate personal loans. Fixed-rate loans have an interest rate that remains constant throughout the loan term. Repayments are predictable, making it easier to budget. The interest on variable-rate loans changes when the prime lending rate changes, resulting in varying monthly repayments. As the loan becomes more expensive, it can strain your monthly budget.

Factors to consider when choosing a loan 

When choosing a loan, pay close attention to:

• Your credit score. This determines whether you’re eligible for a loan, and if so, the amount you can borrow and the interest rate you’ll be offered.
• Your debt-to-income ratio. Are you already using a third or more of your income to service your debt? If so, a further loan may place you under unsustainable financial pressure.
• The interest rates offered by different lenders. These can differ significantly, depending on the lender’s loan criteria and your credit status.
• The loan amount. Avoid borrowing more than is necessary, because all borrowing comes at a cost.
• What the fees are likely to be. These include application fees, origination fees, and any early repayment penalties. It’s illegal for lenders to charge you an upfront fee before you’re granted a loan.
• The repayment period. Longer repayment periods have lower monthly payments but higher overall interest costs.
• The reputation of the lender. Be sure to approach only a reputable lender that's registered with the National Credit Regulator. Inform yourself on how to identify predatory lenders, and avoid them.

The importance of comparing offers from multiple lenders

Lenders typically have different lending criteria, charge varying fees, and offer differing loan terms and conditions. They also have varying reputations and levels of customer service.

Explore which lenders offer the type of loan you require, and try to negotiate favourable terms, rates, and/or fees. The better your credit score is, the greater your negotiating ability will be.

Comparing offers will help you make a more informed decision and increase your chances of securing the most suitable loan with the best terms and conditions for your financial situation. However, be aware that multiple loan applications within a short period can damage your credit score, so exercise caution when seeking loan quotations.

Preparing for the loan application process

There are two important steps to take before applying for a loan.

The first is to review your credit report, check for any inaccuracies, and understand whether you need to improve your credit score before applying.

The next step is to gather the necessary documentation. 

Get your documents ready 

You will need documents that verify your income, employment status, assets, and liabilities, Ndwandwe notes.

The following items will be required:

• A certified copy of your identity document or smart ID card.
• Proof of income/employment, including salary slips, or three months’ most recent bank statements showing salary deposits.
• If you’re self-employed or run your own business, annual financial statements will be required, or failing this, management reports and cash flow projections.

A bank will want to know the purpose of the loan, your existing expenses, salary deductions, and other relevant financial obligations, Ndwandwe says. Details of your employment and credit history are also important.

What to do if your loan application is declined

If your application is declined, the first step is to understand why, says Ndwandwe.

“If it was due to a notice on your credit report, make sure it’s correct. Then address the concern with the credit provider,” he advises. 

A personal loan is not your only option, and your lender may be able to recommend an alternative product better suited to your needs. “Focus on managing your finances better and look for opportunities to earn additional income,” Ndwandwe recommends.

Don’t be discouraged – building a good credit score takes time, he says. Taking steps to improve your score will increase the chances of your next loan application being accepted.

Consistent financial behaviour, a realistic loan amount, stable employment, a low debt-to-income ratio, and having someone co-sign or guarantee the loan also improve your chances of success.

Tip: Knowing your credit score can improve your chances of successfully applying for a loan.