You will hardly find a person who was never thinking of getting a loan, as modern life dictates the terms where most of the things revolve around money. You get married and get a loan for a house, you send your children to college and you get a Students loan and so on.
Knowing how to distinguish good loans from bad ones, how to determine whether the terms are beneficial for you or not, how to make correct calculations and budgeting for repaying borrowed money, will let you avoid mistakes and lenders’ possible tricks. There is no need to hire loan experts to get a consultation or advice.
In just five steps you will get all key knowledge about getting a loan.
Understand the main types of loans
First of all – all types of loans can be divided into two classes: secured and unsecured loans. Secured loans mean you as a borrower provides a bank (or any other lender) with collateral – any valuable asset that bank can use as a guarantee of getting their money back. In a case you will fail to repay your loan the bank will exterminate your collateral to compensate the loss.
Unsecured loans are not backed by collateral, so such loans are of increased risk for the lender and therefore unsecured loans are more expensive and have a higher interest rate.
There are several main types of loans available for individuals and business owners:
Home loans (mortgage)
A mortgage is a general term for Real Estate loans. Mortgages are the longest term loans with an average term of 20 years. In order to get a mortgage loan one has to have an excellent credit history, steady source of income and (typically) 30% of total amount house values (so-called down payment).
Auto (or car) loans are usually secured types of loans. Often car loans are granted on the terms where the car is the collateral for the loan. In this case, the car must be insured against all possible damages as the car technically belongs to a bank until the loan is fully paid off.
Personal loans could be granted to any individual for whatever purposes (purchasing of appliances, furniture, travelling, etc.). Terms and types of personal loans vary significantly as well as interest rate may differ depending on the borrower’s credit score. Usually, the longer the term of the loan, the cheaper it is for a borrower.
Small business loans
Such loans are designed for newly opened businesses or for launching new business projects. The business owner gives a certain valuable asset as collateral and it can be a car, securities, equipment or other liquid assets. Small business loans are granted by non-bank lenders as well, so you may find a list of online lenders willing to give you the needed amount.
Student loans are given for the purpose of paying for tuition and related expenses. There are several Federal programs and loans that offer low-interest rate and flexible terms of loan’s repayment.
Understand loans terms and conditions
There are 8 key characteristics of any types of a loan you should know and pay attention to the first hand:
This is a lifetime of the loan. Mortgages are the longest terms types of loans, while payday loans are the shortest terms ones. The shorter the time period the higher interest rate and the more expensive the loan.
It is the price of your borrowed money that you will add to the “body of the loan” when repaying the loan. For example, if your interest rate is 5%, you will need to return the borrowed amount plus 5% above it.
If you deal with the secured loan your collateral will be exterminated by a lender if you will fail to pay the loan back. The sum of the loan is usually very close to the market value of your collateral.
The sum of the loan
It’s the amount of money lender gives you on agreed terms. This amount is to be returned under the agreed terms.
Some lenders change penalties in a case you will decide to repay the loan earlier than it is stated in your Agreement. Pay close attention to this aspect especially when it comes to short-term and expensive loans as preterm loan’s repayment is not beneficial to a lender.
Terms of repayment (flexible or fixed)
Depending on whether your monthly payments are fixed or flexible, you will either pay the same exact monthly installments during the whole term of a loan, or, in a case of a flexible payments, the amount will depend on certain factors, so it can be increased or lowered from month to month.
Monthly payments are determined by the total amount of the loan, by the term and the interest rate of the loan. The longer the term of the loan, the smaller your monthly payments will be. Also, pay attention to the payments delay fees (some banks allow payments delay without charging any fee).
By giving you money a lender always takes the risk that loan will not be returned due to financial hardship of the client. Therefore, a bank needs to take measures to prevent possible “bad loans” in portfolio. So, by evaluating the eligibility of potential borrower bank estimates the ability of the borrower to pay the loan back. There is few criteria bank pay attention to in order to find out whether you qualify for the loan:
- The credit score and credit history. These factors depend on your previous history of successful loans repayments. The higher the score the more chances to qualify for the next loan.
- Your salary. Your income indicates your ability to make monthly payments after paying all your regular expenses for living, Insurance and utility bills. If your salary doesn’t match required level, you may use collateral to qualify for the loan.
- Collateral. If you do have collateral to secure the loan, chances that you will qualify increase drastically as collateral is bank’s money protection in a case you’ll find yourself unable to pay the loan back.
- Whether you have other unpaid loans. If you have several loans aside from the one you are applying to, you have to have enough funds to afford another loan. Lender considers your loans as a risk factor, especially when it comes to a personal loan that is often taken exactly for the purpose to repay previous loans.
- Whether you have an Insurance policy that protects you financially from losing the ability to earn the money temporarily or permanently.
Know the benefits and risks of getting a loan
There are always risks both for a lender and a borrower. If you borrow money and it turns out you are unable to repay the loan your property that you have used as collateral will be foreclosed. In the worst scenario, there is a risk of going bankrupt if the sum of your liabilities will significantly exceed the net worth of your assets.
The biggest risk appears with the mortgage loan, because not only your house could be withdrawn, but also your initial down payment will not be returned by the bank.
Benefits are obvious: you instantly get the needed funds for purchasing whatever you intend to. If your monthly payments are moderate and your earnings allow you to pay the loan effortlessly, then borrowing money for acquiring a house or another high-value asset is a reasonable choice.