Personal Loans: Things To Consider

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When you’re up against a wall, borrowing money can seem like the best financial option. It involves taking a huge risk, though: A loan can either put you on the road to success or catapult you into unprecedented ruin. That’s why you’ll want to minimize your liabilities by getting educated before you make any major financial moves. To be a savvy consumer, you’ll have to learn what’s available, who’s lending, what makes you an attractive borrower, and how to define those technical terms that lenders toss around with such ease.

Types of Loans

Loans can be secured or unsecured; they can be open-end or closed-end.

Secured loans are defined by the presence of assets (such as a house or vehicle), which are often the very assets you buy with the money you are borrowing. They are often made in larger amounts than unsecured loans because the collateral ensures that the borrower will meet their payments. If they don’t, the creditors can repossess the collateral. Secured loans tend to have longer payoff periods and lower interest rates. Home mortgages and auto loans are the two most common types of secured loans.

Unsecured loans finance bills or services for which there is no tangible asset listed as collateral. As a result, these are based on the borrower’s “creditworthiness” and appeal, rather than on material assets. For example, student debt, medical bills, and credit cards are unsecured. Without an asset to reclaim, the lender is at a greater risk. If you fail to pay, the lender can’t exactly reinsert your infected appendix or revoke your college degree. He’s likely to turn that risk over to you in the form of a strict payment plan at a higher interest rate.

Open-end or revolving loans do not require payment in full by a pre-set date. As long as you keep making the required minimum payments, you can keep paying and keep borrowing up to a pre-approved amount month after month. Credit cards and home equity loans are open-ended.

Closed-end loans do not extend additional credit until the original principal and interest are paid off. You get the entire amount up front; you then pay it off in installments over a predetermined amount of time. These are designed to cover a big expense like a house, car, or education. Payday loans are also typically closed-end, made for a specific amount of money and with a set payoff date.

Types of Lenders

Friends and Family – On a positive note, these are almost always the first place we look if we need to borrow money. When you’re in trouble, it’s natural to turn to your nearest and dearest for financial support. Warning: If you choose to do this, you might be endangering the relationship that made you so eager to reach out in the first place. Few things can damage a relationship as quickly as an unpaid IOU.

Financial Institutions – Banks and credit unions have traditionally been the moneylenders. Walk into any bank, and it won’t take long to figure out that financial institutions are in the business of lending money for a plethora of reasons. Banks are known to limit the borrowers to whom they will extend credit, and they are typically looking to finance a home, car, and business transactions. Local credit unions may be more accommodating.

Products and Service Providers – Some retailers and healthcare facilities understand the limited finances of their community. That’s why outlets such as car dealerships and furniture showrooms offer in-house financing. Similarly, hospitals provide their patients with payment plans. These conveniences may come with a price tag.

Subprime Lenders – As their alternative name suggests, these “second-chance” lenders make funds available to people who have less-than-perfect credit. Whether due to divorce, medical emergencies, unemployment, or just plain mismanagement, borrowers who have missed payments in the past may qualify for new credit through a subprime lender. Subprime loans put lenders at greater risk and tend to carry higher interest rates and fees.

Peer-to-Peer – These online companies match borrowers and lenders. Lenders get higher returns because of the low overhead costs; borrowers get convenience, lightning fast service, and privacy. While this option sounds ideal in theory, P2P loans may not be available to people with low credit scores.

Getting approved

Your best approval strategy is to get steady employment and improve your credit score. Assuming you have avoided bankruptcy, once you accrue a year’s worth of on-time payments to all creditors, your score will take a healthy leap.

In addition to your on-time payments, another strategy to get your score up is to get approved for a smaller debt for a shorter time. Demonstrate your ability to pay. Consider saving to make a larger down payment. A larger down payment means you have less to borrow and demonstrates to the lender that you have had the patience and discipline to set money back for a significant purchase. These actions show off your financial credibility

It’s always important to be informed! Once you have settled in on your best option, read all the fine print. You’ll want a fixed interest rate to avoid a potentially crippling rate hike.

Avoid applying for multiple credit cards. Your credit score takes a hit every time you apply. Also, avoid borrowing more than necessary. Credit card and home equity lenders may offer you a greater line of credit than you need for your current expense. Taking advantage of such an offer is seldom a good idea.

Just because you can borrow doesn’t mean that you should. If you find yourself constantly borrowing to meet your financial needs, it might be time to review your spending habits and other potentially harmful patterns in your financial behavior. In some cases, it might be better to avoid borrowing altogether: For example, if your credit score is low, try to avoid accruing unnecessary debt for purposes of comfort, convenience, or status.

Learning Lender Language

ARP (annual percentage rate) – This number tells you the interest rate you will pay on any outstanding debt. Rates vary from around 6% on home mortgages to 400% on payday loans.

Collateral – This is the asset that you offer your lender to guarantee that you will pay up or surrender your property. Houses and car titles are collateral.

Default – Failure to repay a debt on time places you in default and bottoms out your credit score.

Hidden fee – A cost that the borrower is not expecting may be called a hidden fee, which may, in turn, impact the overall expense of borrowing.

Payment plan – The schedule that a lender provides for repayment outlines the amount of money due at different dates over the life of the debt.

Personal Loan – Financing that helps you meet your immediate expenses is also known as a signature loan, meaning your name is your promise to pay.

Outstanding debt – The unpaid portion of your debt is the balance still owed to the lender.

TAR – The Total Amount Repayable will give you the bottom line on your loan because it includes your principal, plus fees and interest. TAR is a top consideration for any planned borrowing.

Financial advisors agree that taking on debt is a serious matter. Quality financial advice is readily available for those who want to evaluate the best way to handle their expenses, so make sure to review all the relevant information and consider all your options carefully before you commit to a decision. Borrowing is a significant risk, and you need to know the difference between what sounds good and what’s right for you.

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