Loans might seem simple but can be a bit complex and there are different types of loans to suite your lifestyle the best. Loans can help people pay for high-cost expenses upfront for major life finances. We break down the basics of what you should know before considering taking out a loan.
There are three factors to consider when taking out a loan such as principal, interest, and term. The principal is how much money you plan on borrowing and the interest rate is the percentage that you will be charged by a financial institution for lending you the money. The term is the amount of time you have to pay back your loan amount and is crucial in deciding which loan is best for you.
Another thing to think about is whether you want to take out a secured or unsecured loan depending on whether or not the loan is protected by collateral. You might have to consider using one of your assets as collateral that is something valuable the lender can take as repayment if you default on your loan and are unable to pay it back.
Common forms of collateral can be your house or your vehicle that are typically used for secured loans. Unsecured loans often require no collateral but has a higher interest rate as it can be riskier to lenders. Secured loans commonly require collateral with a lower interest rate and is less risky for lenders.
A key factor to look out for is interest rates that can be influenced and fluctuate without certainty depending on the criteria that is different for every lender based on a set of factors. This set of factors weigh in on whether you’re eligible for a loan and what your determined interest rate will be.
A common factor considered by lenders is your credit score as people with higher credit scores are qualified for lower rates and it’s recommended to try improving your credit score before applying for a loan. Another factor is time, the more you borrow and the longer the term results in a higher interest rate.
Another factor in your interest rate will depend on your life situation and lenders look for things that will suggest you’ll be able to pay back your loan. Common factors can influence whether you’re eligible for a loan such as having a good employment history, not having other debts, having a long-standing relationship with a financial institution, and in some cases having a cosigner. In certain situations, some loans can require a cosigner who will be responsible for paying the loan if you don’t pay off your loan.
Having a cosigner can help you but can impact their own financial situation as it can impact the cosigner’s credit history as if it was their own loan. If you need a cosigner, you should appoint someone you completely trust and that trusts you.
Another important factor in taking out a loan is to see whether it has a fixed rate or variable rate. Fixed rates stay the same through your entire term of your loan compared to variable rates that can fluctuate based on a chosen index. For variable rates, if the chosen index goes up or down your rate can increase or decrease accordingly.
Fixed rates are predictable that are easy to plan for your budget with generally higher interest because the lender must anticipate that the rates might rise in the future. Variable rates are more unpredictable and generally offers lower interest rates.