When it comes to loans, informed decisions are the best decisions. Whether you need money to buy a house, study at the university of your dreams or put money towards a personal endeavor, you’re bound to apply for a loan at one point or another. This article is here to lay out all the loaning basics and help you make the best-informed decisions.
What are Loans?
In the most basic terms, loans are essentially borrowed money in exchange for future reimbursement. Lenders range from banks to credit unions offering a fixed amount of money called principal-the initial sum borrowed in a loan. The lenders often require an additional interest payment on top of the principal sum.
Typically referenced on an annual basis, interest rates exist as compensation for the lender in exchange for their assets. When applying for a loan, a borrower should remember that interest rates are integral to most lending transactions and can come in form of cash, real estate, or other consumer goods.
For instance, if your $10.000 car loan comes with a 5% annual interest rate, your monthly interest rate will amount to roughly 0.4%. While this seems reasonable, interest rates may also entail 3 areas of complications worth considering:
- Not all interest rates come in a fixed amount. Some may be riskier than others, due to their variable nature. Long-term loans are the most typical examples of interest rates changing over time.
- The interest rate of a loan should not be confused with its annual percentage rate (APR). Your APR includes both the interest rates and other fees involved in your general loan. These may include discounts, broker fees, and rebates. Thus, when comparing loans, you should take a look at the APR rather than the interest rate to decide which is better suited to your financial situation.
- Do not forget about your credit score. Annual percentage rates are highly dependent on one’s credit score, offering a better deal to those who have a higher credit score.
Naturally, interest rates can vary depending on the loan. While short-term loans initially appear to have higher interest rates, it’s the long-term borrowers that end up paying much more. The logic of this is simple: the longer the life of the loan, the longer the existence of interest rates. Bottom line; do your homework and familiarize yourself with the terms of your agreement.
Loaning: The Borrowers
When applying for a loan, borrowers may be asked to provide some details for the lenders’ consideration. These details may include:
- The reason for borrowing
- A Social Security Number (SSN)
- Credit Report and History
- Other case-specific information
The application process for a loan, as mentioned above, is heavily reliant on the borrower’s creditworthiness. A lender is within their full rights to deny a loan application (given that they will provide reasoning) based on a low credit score. Let’s consider a few scenarios:
- Your credit score is at least 640 and your debt-to-income ratio is below 36%. This is a great place to be, as you will have no problem getting approved for a loan.
- Your credit score is on the lower scale and you simply do not have enough time to raise it before applying for a loan. This is not an impossible situation, and luckily, there is also a way around it. You need to simply find someone with a good credit score willing to co-sign your loan.
- You have a low credit score and are unable to find a co-signer. Not to worry. You are still eligible to apply only with the precaution of your loan being deemed subprime and carrying above-average interest rates.
- If you have a low credit score and are looking for alternative sources, look no further than friends and family.