Loans are not all bad. In fact, taking out a loan can do great things for your credit score if handled responsibly. Here are a few things to consider before taking out a loan.
Taking out a loan for whatever reason requires thorough consideration and planning beforehand. While loans do have the power to bail you out in times of financial calamity or allow you to pursue investment opportunities when they pop up, they can also hurt your finances and cause damages that can take years to fully repair. If you're on the fence about taking out a loan, here are five things you should consider:
Today's loan market has increased considerably in size and variation. You don't just have one or two options on the table; you have traditional mortgages, student loans, equity loans, personal and business loans, etcetera. Each type of loan has its own unique pros and cons that you'll need to be wary of. For instance, a personal loan has the advantage of being flexible and versatile but the drawback of potentially high fees and interest rates. Equity loans, on the other hand, have the benefit of lower fixed interest rates but the disadvantage of having to commit to a larger lump sum. It may be worthwhile approaching a financial advisor for help on what type of loan best suits your financial needs and personal circumstances.
For banks and private lenders to make money off of the loans they underwrite, they charge a variety of fees, one of which is interest. Your loan's interest rate will affect how easy or difficult it is to repay the loan over time. Before you take out any loan, make sure to do a comparison shopping of the interest rates offered by different lenders. Knowing exactly how much interest you'll have to pay over the loan's term is important to determine whether or not you can actually repay it or if it's too high of a loan to commit to.
Good credit standing tells your lenders that you are trustworthy of their money. A low credit score, on the other hand, and a credit history riddled with defaults and delinquencies reflect a financially irresponsible borrower. The higher your credit score is, the better your chances of getting approved for a loan at the most ideal terms. You might think that a single percent difference in interest rate isn't a big deal, but it's actually equivalent to thousands of dollars over time. For instance, the difference in paid interest between six percent and eight percent on a $25,000 loan is over $1,400.
Assets and Liabilities
Lenders use intuitive loan management software to look at every financial record and transaction you have that can shed light on whether or not you're creditworthy. One of these pieces of information is your list of assets and liabilities or net worth. Ideally, you'll want your assets, i.e. investment accounts and real estate, to be greater than your liabilities, i.e. student loans and credit cards. Calculating your net worth is a great way to determine what terms you should be entertaining from lenders. Knowing your net worth is also important for personal reasons as well. It lets you keep track of your finances and gives you a big picture view, so it's easier to spot when liabilities are overrunning your assets.
Consequences of Not Being Able to Repay Your Loan
Before you take on a loan, make sure you know the worst-case scenario when you fail to make repayments. Fortunately, a loan that gets downgraded to delinquency status sounds more terrifying than what actually ensues. The bank or private lender will often sell your loan account to a third-party debt collection agency who will then contact you to set up a new repayment arrangement. During this entire time, your credit score will likely take a hit. In addition to the legal side of loan delinquency, you'll also want to consider the personal financial impact that this brings. For example, if you recently lost your job, an unpaid loan looming over your head can make it even more stressful to find a new source of income.
Taking out a loan shouldn't be something you decide in a matter of hours or even days. Take as much time as needed to assess your existing financial condition and your ability to repay the loan. Moreover, make sure to exhaust all your lender options before picking one.