by Most people apply for at least one loan during their lifetime. Whether you need it for a car, an education, or a home, a loan can come in handy for large purchases. If you’ve never applied for a loan before, the process can be intimidating. To put you at ease, here are six things you should know when taking out a loan.
1. You May Need to Verify Your Income
Many lenders won’t approve borrowers for loans until they receive a verification of income. This makes sense if you consider the financial risk the lender assumes with each loan approval. It would be easy for an applicant to lie about earnings if income verification was not required.
You can use a couple of recent pay stubs, your most recent W2 statement, or bank statements as income verification. Check with your loan provider to see what documents will satisfy their income verification requirements. You may need to show a proof of income letter from your employer if you’ve recently taken a new job.
2. Your Credit Score Impacts Your Chance of Approval
Your credit score gives lenders a good idea of how responsible you are with money. Credit scores range from 300 all the way up to 850. Most people have a score somewhere between these two numbers. Different lenders have varying minimum credit score requirements. For example, some may not offer financing to anyone with a credit score below 760. Other lenders may approve people with lower credit scores but attach a higher interest rate to the loan.
Higher interest rates help offset some of the risks the lender takes by approving a borrower with poor credit. That’s why people with low credit scores often get the least favorable loan terms. The higher your credit score, the more likely you are to get favorable loan terms and interest rates.
3. There Are Extra Costs Associated With Loans
Just because you make enough money to get approved for a loan doesn’t mean you can comfortably afford it. Many people end up with car or mortgage payments they can barely make because they have stretched themselves too thin financially. Before taking out a loan, do some math in advance to make sure you can afford your loan payments.
Many loans come with fees attached to them. For example, student loans often have an insurance fee, a disbursement fee, a repayment fee, and an origination fee. These fees can quickly add up and lead to a larger monthly payment than first expected. Likewise, if you’re buying a car or home, you’ll need to consider sales tax, property taxes, and insurance costs. All of these factors can increase the total loan payment. It’s important to know how much loan you can really afford before you commit to anything.
4. There Are Two Main Types of Personal Loans
When it comes to personal loans, there are two main types from which you can choose: secured and unsecured. A secured loan is one that’s backed by a savings account or some other type of collateral. The lender can usually seize the collateral if you fail to repay your loan.
With an unsecured loan, the lender decides whether to approve you based on your financial history. It can be harder to qualify for an unsecured loan than a secured loan because there’s no collateral involved. Unsecured loans sometimes come with higher interest rates to help cover some of the lender’s financial risk.
5. You Should Carefully Review the Loan Terms Before Signing
Most lenders have varying loan terms, so it’s essential to review the terms before getting into any contractual financial obligation. Some loans have pre-calculated interest, which means the interest is included in the monthly payments. Others may have compound interest, which means the interest keeps building up while you’re paying off the loan.
Some loans may have variable interest rates that can fluctuate wildly during the life of your loan. Others come with fixed interest rates that remain stable no matter what happens with the market or economy. To make sure you’re getting the type of loan you want, thoroughly review the terms before signing any closing documents.
6. There May Be a Penalty for Paying Your Loan Off Early
If you like to pay your loans off quickly, be careful. Some loans come with prepayment penalties attached. It is fairly common for personal loans to charge a fee if you pay the loan off before the due date. Lenders will sometimes use this loan tactic to ensure they get the full interest amount from you.
Before signing on a loan, check to make sure there is no prepayment penalty. If there is one and you know you want to pay the loan off early, get a different loan. Ask your lender if there are any loans with similar terms that don’t charge a penalty for prepayment.
Taking out a large loan can be an intimidating process, even if you’ve done it once or twice before. Knowing what’s going to happen can help you feel much more comfortable. Before applying for a loan, review the above list of things to expect. That way you won’t face any unpleasant surprises during the loan application process.
