You may be familiar with the concept of a loan, but do you know how it works? Before you take out a loan, there are many elements to consider. Here’s your ultimate financial guide to help you understand and acquire the best possible loan for you or your business.
The Most Common Reasons to Take Out a Loan
Generally speaking, someone will take out a loan to carry them financially as they weather a storm or achieve success. In theory, they will be on better financial or personal standing as a result of the loan. This end result may help them repay their debt.
Most people take out loans to finance an important purchase or support a venture. The most common loans for these purposes are mortgages, car loans, student loans, or business loans.
Strategic loans for refinancing or to consolidate debt are also common. Despite being counter-intuitive, a person can take out a loan with lower monthly payments and interest rates to pay off existing debt.
Sometimes the only thing standing between a person and financial or even medical ruin is a personal loan. Despite the unwanted debt, the extra cash can prevent a disaster or tragedy.
Many other people will take out a loan for personal reasons. It’s not uncommon for someone to finance vacations, weddings, and other important life events with the help of a personal loan.
These are all legitimate reasons to take out a loan. However, they can create financial problems for anyone who doesn’t understand loans, overestimates their ability to repay the loan, or both.
The first step is understanding one’s objectives and financial stability. You may benefit from setting a long-term financial timeline to see if a loan fits into your budget. Then you can better determine if securing a loan is the right move.
Understanding Your Loan
Most people are familiar with late fees and interest rates, but lesser-known details of a personal loan can jeopardize your financial well being. The following is a review of loan terminology and how it affects a loan. Most importantly, we’ll take look at how these items can be damaging if misunderstood.
What’s an Origination Fee?
An origination fee is an upfront cost that a bank charges you to secure a loan. Typically, these are one-time fees that are a percentage of your total loan balance. Sometimes origination fees include several different fees that are part of securing your loan.
What’s the Risk?
Depending on your finances, paying a high upfront fee may not be wise – even if you would secure a lower interest rate. Balance your long-term and short-term financial goals and obligations before committing yourself to expenses you can’t manage.
You may be familiar with your interest rate from a monthly credit card statement. Your annual percentage rate (APR) is your interest rate for a whole year, including other fees that went into securing your loan.
What’s the Risk?
If you were to borrow $1,000 with a 10% APR, you may assume you’ll pay $100 in interest per year. However, interest is charged in smaller increments throughout the year, and banks may charge fees at any of those junctions.
What’s more, each of those charges may be added to the total balance of your loan. This results in compound interest, where you are now paying interest on those fees.
It’s critical at the start that you understand the fee structure of your loan. Then, compare what you find to your own finances before you move forward.
What’s a Term Loan?
When you agree to a term loan, you agree to pay the loan balance plus interest over a set period of time. Term loans are usually used to finance something that will generate capital, like a small business. That way the bank can have confidence that you will have a means to pay off the loan on time.
What’s the Risk?
Before securing a term loan, be confident that you can meet the time obligation. You will encounter penalties if you fall short. Be sure you are able to secure sufficient income. If not, your loan should help you develop the means to repay.
What About Late Fees?
Late fees are added to your balance when you fail to make a monthly loan payment on time. They are determined at the start of the loan, but they often grow costlier with repeated late payments.
What’s the Risk?
The risk with late fees starts at the beginning. Most borrowers are confident in their choice to secure a loan. They believe they will have the means to consistently pay on time. Additionally, there may be other appealing benefits of a loan that will overshadow its late fees.
Depending on your late fee structure, those moments when you are unable to pay may be the most painful. If you’re already unable to pay on time, how will you pay a late fee?
Consider your repayment history and financial expectations before signing. An otherwise great plan with high late fees is not the right choice for everybody.
Acquiring Your Loan
There are three essential steps to securing your loan, though they differ from person to person. Here’s what to expect when you start the process.
Getting pre-qualified is the first step towards securing a loan. Simply prepare a statement outlining your overall financial status. This should include all assets and any existing debt.
The key to getting pre-qualified is identifying all possible contributors to your success. You can even include the values of jewelry or antique furniture in your pre-qualification statement.
Checking Your Credit
Most banks will check an applicant’s credit history before offering them a loan. They will run your credit through one of two credit unions – TransUnion or Equifax. This can be a barrier to applicants with low credit scores and may affect interest rates for those that get through.
Some financial services organizations offer loans without credit check. Borrowers who need an immediate loan can use these services quickly and with limited red tape. Be sure to review all statements regarding interest rates and fees before securing either type of loan.
Choosing a Loan
At this stage, you should consider all of the items we discussed in terms of understanding your loan. Loans are commitments that may last a lifetime and even beyond your death. Your preparedness now will give you the greatest possible chance of success.
What’s the Next Step?
If you’re ready to take out a loan, don’t hesitate to further your education or speak to an expert. Contact us today for professional loan management learning services.