Table of Contents
Whether you need money to buy a house, study at the university of your dreams, or put money towards a personal endeavor, you are bound to apply for a loan at one point or another. But wait! Do you have enough information?
This article is an overview for understanding loans, loan categories, interest rates, the game players during the loaning process, and the consequences of delay in repaying the loan. The information provided enables you to have a broad understanding of how loans work. That eventually helps to make informed decisions.
What is a Loan?
In the most basic terms, loans are essentially borrowed lump sums in exchange for future reimbursement against a sort of collateral. Lenders range from banks to credit unions offering a fixed amount of money called principal / the initial sum. Lenders often require an additional interest payment on top of the principal sum. The type of collateral used for getting the loan from a specific lender has an influence in defining the loan type. To put it another way, it is what borrowers pledge to get a certain amount that defines the category of the loan.
If we wink at the loan source for a moment and concentrate on the guarantor, loans are either secured or unsecured.
Secured Loans Vs Unsecured Loans
A secured loan is a loan that borrowers secure against an asset or liquefiable item they own. With this collateral, they pledge the return of the borrowed amount to the lender. Examples of secured loans include vehicle loans, mortgages, saving loans, secured credit cards, and life insurance loans. Depending on the desired amount and loan provider, the property you own, whether it is a house, vehicle or any type of valuables can serve as collateral. Life insurance, bank accounts, stocks, and bond investments can also serve the purpose.
On the other hand, unsecured loans do not require collateral the same way secured loans require. These loans sound easier to get and process. There is no commitment of a physical asset for serving as collateral. Examples include payday loans, personal loans, instant loans online, and personal loans for business use.
Now one may ask whether student loans are secured or unsecured. This is a critical question. One should note that even in the case of bankruptcy, student loans remain there for the borrower to repay. The collateral is the Federal Government that can follow many procedures to get the amount repaid. In all cases, in the absence of collateral, the unsecured loan approval is contingent upon the credit history and level of income.
Who are the Loaning Process Game Players?
Just like any game, the loaning process requires the participation of specific players. In games, participants enjoy competing against each other. Here, the story is different. For the game to be successful and enjoyable, one side should assist the other.
When John saved some funds from a project he executed, he wanted to invest in a new one. The collated amount was little. So, he decided to refer to the bank. Unfortunately, his query was rejected due to a lack of convenient collateral. He kept the faith, went online, did a good search, and asked an online agency to provide him with an instant loan. The agency checked the credit history of John, examined the savings he made as well as his income. Contrary to the bank, the online agency found John’s query beneficial for its success. Within a matter of hours, it accepted John’s proposal. The loaning process started.
Basically, once two differing parties’ interests meet, the exercise starts. It commences by the borrower in a close cycle with the lender. The loop goes on and on unless there is a delay in the repayment process. At this stage, other players, such as the credit bureau, may interfere to adjust the situation as a referee.
What is the Interest Rate?
Now that John received the loan, he needs to reward the loaning agency. Lenders, on the other hand, are not charitable organizations. They are just like us, trying to run a business and earn money. Therefore, they require compensation in exchange for their services and the cash amount they provide.
In fact, interest rates are an integral part of the loaning process. They come in the form of cash, real estate, or other consumer goods used as collateral. The calculation of the rate is based on many factors. These include the loan amount, the lending firm, the objective of the borrower behind loaning, the collateral, the credit history. It may also be influenced by employment status. One needs to remember that lower interest rates have an inverse relationship with high credit scores. Instant loaning firms offer John a better rate. He is high on credit score and has a previous story of business success. However, the rate, due to the absence of a physical asset, will probably be slightly higher than that usually provided by banks.
How is the Interest Rate Calculated?
Understanding interest rates on loans is really a necessity. John’s $10.000 instant loan comes with a 5% annual interest rate. His monthly interest rate amounts to roughly 0.4%. While this seems reasonable, interest rates may also entail three 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. Considering this fact, John stretched his loan over three years only.
- The interest rate of a loan should not be confused with its annual percentage rate (APR). The APR includes both the interest rates and other fees involved in the overall loan. These may include discounts, broker fees, and rebates.
- Annual percentage rates are highly dependent on one’s credit score, offering a better deal to those who have a higher credit score.
- 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.
Things That Dummies Need to Consider When Loaning
A. Highlights on Loans and Relevant Advices
- Do your homework and familiarize yourself with potential financial institutions and the terms of the agreement they offer.
- The duration of each loan differs as so as its perception. Understanding a car loan is not as understanding a mortgage loan. For instance, the car loses its value over time, while the house value usually increases. In this respect, interest rates and collateral value differ.
- When comparing loans, you should look at the APR rather than the interest rate alone to decide which suits your financial situation better.
- A longer loan term will result in lower monthly payments, but higher interest costs.
- The borrowed amount is not a gift. Borrowers must be aware of methods to utilize the loan wisely and cover the debts as per the defined schedule.
- The application process for a loan is heavily dependent on the borrower’s creditworthiness. Make sure you retain your credit score.
- Helping resources such as the internet and financial advisors are there if the borrower has any doubts.
- There are many online loan networks. Borrowers may refer to them to avoid the hassle of paying visits to loaning institutions. However, if you need to visit a financial agency in person, just make It.
B. Loaning Relevant Procedures
When applying for a loan, borrowers will be asked to provide any of/all the following details:
- The objective behind borrowing the amount
- Social Security Number (SSN)
- Home address
- Employment details
- Bank Account Statement
- Credit Report and History
- Other case-specific information
C. Loaning and Creditworthiness
The success of the loan application is heavily reliant on the borrower’s creditworthiness. It is within the full rights of the lenders to deny a loan application based on a low credit score. Let’s consider a few scenarios:
1. 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 loan approval.
2. Your credit score is on the lower scale and you simply did not think about how to improve your credit score. In this case, you may find someone with a good credit score willing to co-sign your loan.
3. 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. However, you need to select short-term payday loans to avoid paying the high interest in the long run.
4. If you have a low credit score and are looking for alternative sources, look no further than friends and family. However, make sure to handle the loan responsibly. That helps avoid any harm being caused to the caring people surrounding you.
Things That Lenders Consider
As one can understand from the previous paragraphs, lenders will look for means that guarantee the loan repayment. Lenders will prefer dealing with those that have a stable income, good employment history, and paid previous debts increasing their creditworthiness. They will of course feel more comfortable with those who have valuable and tangible collateral. All that counts. However, depending on the loan amount and available down payments, lenders withdraw some conditions and force the remaining. In other words, what matters to lenders matters to borrowers as well. It is a game when both sides wish to win. Therefore, all should wisely and responsibly play the game.
What Happens if You Do Not Repay Loans?
The frequent delay in repayment leads to an increment of interest rates. Rates can exceed the initial amount borrowed. For many Americans, loaning turns into a deadly trap. Once the credit history is damaged and the interest rate goes way behind the amount borrowed, it would be nearly impossible for the borrower to survive. In such situations, borrowers will either route towards debt consolidation or declare bankruptcy. In either case, maintaining the situation takes many years. Therefore, always find your way out of debts. Deal responsibly and wisely with amounts borrowed.
General Tips When Thinking of a Loan
- Work on maintaining a good credit history
- If not employed, find a stable job that allows you to secure an income
- Do your search efficiently in terms of grasping information about loaning
- Follow steps that help you overcome financial constraints
- Deal cautiously with loans regardless of their type. The loan may cost you your future loaning options, your house, and your personal credit. It might also affect your future employment opportunities if employers demand your credit history.
Informed decisions are the most successful ones. If you are a dummy about loaning, start from exploring your own needs to carry on to exploring the financial institutions and loan types that best meet your query. Eventually, learning helps you decrease risks and swim safely in a crystal clear blue sea.