Loan & Interest Rate
An interest rate is a percentage of the total sum of money you borrow from a lender. It’s the amount you need to pay to the lender above repayment of the principal sum. Think of it as a fee that you pay on an annual basis for the lender’s services.
Your total interest rate will depend on the amount of money you borrow, the type of your loan, any potential down payment you provide, the repayment period, your income, and your credit score.
Fixed vs. Variable
You can choose between Fixed and Variable interest rates.
A fixed interest rate will remain the same for the entire term of your loan.
In contrast, a variable interest rate will change over time, and it can go both up and down. Variable-rate loans usually have lower interest rates.
Loan & APR
An APR, or an Annual Percentage Rate, includes your interest rate payments. It also includes all the other annual fees that you need to pay. Those fees can include origination fees, that is, fees for filing paperwork for getting your loan. They can also include closing fees and any other annual fees that your lender charges for their services.
Make sure you check the APR when considering a loan. An APR is a much better representative of the total cost of borrowing than an interest rate. It will show you the exact amount you need to provide per year so that you can know whether or not you can actually afford the payments.
Secured vs. Unsecured Loans
Secured loans, also known as Homeowner Loans, are loans that require collateral from a borrower. Collateral can be a cash deposit, a home, a car, stocks, or any other valuable asset. Even if you don’t place your home as collateral, you still need to be a homeowner to qualify for a secured loan. If you default on your loan, that is, fail to provide timely and in-full payments, your lender will seize the collateral.
It’s much easier to get approved for a secured loan, and the interest rates are lower. You can get it even if you have a poor credit history. This is all because the risk is lower for the lender. In case of a loan default, they have your collateral to fall back on.
On the other hand, unsecured loans don’t require any collateral. They do require a good to excellent credit score, and their interest rates are higher.
They’re higher precisely because the lender has no asset to rely on. You can get approved only with information about your credit history and income. If you default on your loan, the lender loses money and has no collateral to fall back on. They can only resort to a lawsuit or debt collectors.
However, an unsecured loan allows you the flexibility of choosing your repayment period.
So, if you can qualify for an unsecured loan, and need a smaller amount of money that you can repay in 2-10 years, make sure you always provide full payments on time.
If you can’t afford the payments, you can consider extending your repayment period. That way, you’ll reduce your monthly payments, but you’ll also deal with a higher interest rate. Consider all your options wisely.
How Do I Get Approved for a Loan?
When looking to take out a loan, the last thing you want is to be denied. As already mentioned, to get approved for a loan, you need to make sure you have a good credit score.
7 Steps Guide To Get A Loan
1. The first step you should take is to check your credit report for any potential errors. Mistakes happen, so you don’t want any potentially inaccurate information on your report to be the reason your loan application gets denied. Therefore, contact the major credit bureaus to check your credit report before applying for a loan.
2. If you use credit cards, your credit utilization ratio will also greatly affect your chances of loan approval. You need to maintain a good credit utilization ratio, that is, always pay off your credit card balances on time and in full.
3. Keeping your old accounts open, even if you paid them off, will also improve your credit score. That’s because you’ll increase the length of your credit history.
4. If you have any debts, be sure to pay them off before submitting your loan application. You’ll have a higher chance of approval, and a better credit score.
5. Your income also plays a huge part in your loan approval process. If you have a steady job, your lender will feel more comfortable lending you their money, because they will see that you can actually afford to pay it back. Therefore, don’t switch jobs if you plan on taking out a loan. Show that you have a steady income that allows you to pay back what you owe easily.
6. Always use less than 30% of your total credit limit every month. That will show your lender that you’re a responsible and trustworthy borrower, and it will improve your credit score.
7. Also, never miss any payments you have. A single missed payment can be devastating to your credit score, and limit your chances of loan approval.
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If you fail to provide a loan payment on time and in full, your lender may offer you a grace period to provide your missed payment. This is also known as a delinquent loan, and the grace period allows you to get out of the delinquency stage.
If a certain period of time passes and you still don’t provide your missed payment, you greatly increase the risk of loan default. Both delinquent loans and loan defaults can severely affect your credit score.
Loan-to-value (LTV) ratio is used for determining the size of a loan. A lender calculates the LTV ratio based on the value of the asset that you want to purchase with the loan. This ratio is commonly used to determine the value of auto loans and mortgages.
Installment loans are loans that have a fixed repayment period. You need to repay an installment loan by providing regular installments in fixed time intervals. The most common types of installment loans are personal loans, auto loans, and mortgages.
A cosigner is a person who guarantees that they will repay your loan if you fail to do so. They help you get approved for a loan due to their excellent credit score and high income. A co-borrower, also known as a joint applicant, is someone with whom you get and share a loan, together with all the responsibilities for repaying it.
Debt-to-income (DTI) ratio is used to determine whether or not a borrower can provide on-time, full payments every month to pay off their debt. A lender calculates this ratio by looking at a borrower’s income and spending habits, and the amount of debt they carry. It will be much easier to approve you for a loan if you have a lower DTI ratio.
An interest-only loan is designed for the most qualified borrower. You must have an excellent credit score and a very high income to get approved for an interest-only loan. With this loan, you can postpone paying off the loan, and only pay the interest rate.
If you have one or more loans that you have trouble paying off, you may turn to loan refinancing. When you refinance a loan, you can get lower interest rates. You can also reduce the amount of money you need to pay back. You can also use refinancing to get a chance to pay lower monthly payments over a longer period of time. However, this would increase the total amount you need to repay.
Loan amortization is a process of spreading out your loan payments over a set period of time to pay off your principal sum and the interest rate in different amounts every month. All your monthly payments stay the same, but their parts (the principal sum and the interest rate) change over time.
At the beginning of your repayment period, you’ll pay higher interest costs, which will decrease over time. When it comes to the principal, the amount to pay will be lower at the beginning, while increasing over time.
The most common types of amortized loans include mortgage, auto loans, and student loans.