Some folks constantly talk about the negatives of borrowing money, but understanding credit and loans is crucial for those who want to make investments in homes and other large purchases. In fact, knowing the loan life cycle and how to get the most out of different kinds of loans can give you purchasing power in making your aspirations happen. There’s much for the borrower to understand before making an appointment with a loan officer. Regardless of the kind of loan one takes out, there are five basic steps to every loan cycle.
And so it begins — the hunt for credit — but before a borrower applies, they should shop around. Sometimes, sticking with your established bank is smart because it builds your relationship with them, which is more useful than you may think. This is especially true in getting approved, because they know your spending history. And on things like a mortgage on a $300,000 house, an extra percentage here or there may add up to thousands of dollars.
Meet a loan officer or study the terms to clarify whether it’s possible to get a loan. If not, a loan officer may be able to suggest alternative solutions for the borrower. Once the application begins, it’s a simple process involving a credit check. You’ll need recent pay stubs, maybe a letter from your employer and possibly two years of income tax filings and W2s and 1099s. More may be needed for major loans, like a mortgage. Find out what's required and get organized, because it doesn't just save hassle, it makes you look like a better prospect.
A credit check will be done. They may contact your employer. The borrower may receive full approval right away or it might be a conditional approval based on providing more supporting documents. Or, you could be rejected or offered something less or other than they’d been hoping to receive. Getting a full approval usually comes down to having all the right documents in order before the application is submitted (and meeting the borrowing requirements, of course).
Once approved, there’ll be a contract to sign with a payment schedule provided. A condition of the loan might be purchasing loan insurance, which ensures the lender gets paid should calamities or ailments befall you. This insurance can be exorbitant, so be sure to understand what you’re agreeing to, and remember you can always go elsewhere or decline the terms/loan at this point instead. Not all lenders require insurance, and some that do will make it available affordably, in which case it can be a good option.
Hurrah, you’ve succeeded and gotten your loan. Depending on your loan purposes, how the money is paid out varies. For a car loan, the money may go straight to the dealer. Or maybe you’re on the hunt for a vehicle yet to be decided, in which case they may deposit the cash into your account to spend when ready.
On a debt consolidation loan, the lender will pay off all the bills covered by the loan — everything from your electricity bill to the car loan, if that’s what your intention was — and then you’ll have zero balance on all those debts (until the next billing cycle, anyhow) and then the payments will begin. Ask the lender earlier in the process how the disbursement will happen, if you're unsure.
Typically, an automatic monthly payment is set up for the repayment schedule. Biweekly can be possible, even weekly, for things like mortgages, and should be considered by those who are eligible, as studies show these loans tend to pay down faster and incur less interest. Check the fine print before paying things off early, as some lenders will penalize this. If you are indeed able to pay things down early, be careful to specify you want lump payments credited against the principal of the loan, that is, the sum you borrowed, rather than against the principal-plus-interest.
Once you’re zeroing in on the final payment, be sure you contact your lending institution to find out if there are any loopholes or hidden interest amounts you might not have anticipated. There are the odd horror stories from those who thought they’d paid a loan off, only to get burned by being unaware of conditions of repayment.
Student loans are disbursed before school begins, then they’re given a six-month grace period after the education period concludes. After that, it’s an estimated 10 years of repayment. A misconception is the loan can’t be repaid until the grace period lapses, but smart borrowers will make steady, small payments against the loan principal for the duration of their education, which can save them a lot against interest in the long-term.
Read up on the struggles many face in paying off student loans before you take one out, and only borrow what you need: It’s not free money and loan forgiveness on student loans is far harder to get than most students believe.
There are various types of personal loans, then over a dozen types of business loans, and each has its pros and cons. With personal loans, most have higher costs or risks associated with them. Groucho Marx was famous for quipping, “I refuse to join any club that would have me as a member,” and the same could be said about accepting loans from some sources, like payday loans, because the terms are so heavily stacked in the lender's favor. It’s a caveat emptor scenario, so “let the buyer beware.”
- Unsecured loans are personal loans that can be taken out without having to use anything as collateral. They may have higher interest rates, because the loaning organization perceives the risk to be higher. Student loans fall under this category.
- Secured loans either need a co-signer or collateral in case the borrower should default on their payments. Lenders feel more secure about this loan type of loan, so they tend to have lower fees and interest. Risk, however, lies with the borrower, as missed payments mean the collateral is taken by the bank, regardless of how much remained on the loan.
- Lines of credit can be a revolving door of money, at the borrower’s discretion, with interest on what’s used until it’s paid off. Like a credit card, sort of, but with cash and usually better interest rates.
- Riskier loans include things like “title loans” in which one takes out a loan using their vehicle as collateral, as well as “payday loans,” in which one gets a small loan for quick repayment. The trouble with both, particularly the payday variety, is the interest and fees can be as high as 391%. These are the sorts of loans that should only be taken out in true desperation.
- Debt consolidation loans take care of multiple debts by blending them into one loan with one payment. This can increase the debt owing, but the simplicity of having a weighted-interest loan repayment monthly can be worth it versus, say, 10 different debts on which the borrower pays the minimum while carrying balances forward monthly, especially if it means payments are on time and establish a better credit rating.
- Fixed- and Variable-Rate loans either have a fixed interest rate for the life of the loan — the most common personal loan — or a rate that will vary as the prime lending rate rises and falls over the course of the loan.