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Picking up the Pieces: Do These 3 Things Before Considering Getting a Loan

Securing a loan puts money in your wallet. It also means a legal obligation to repay. There are no free rides when you borrow money. But, if you know enough, you can find loans that best serve your financial wants and needs.

Personal lending plays a major role in driving the economy. With access to “cheap” credit in an era of high demand for consumer goods, borrowing increases economic production and growth. However, excessive debt, measured against income, also risks huge personal and family loss.

There are several good reasons to borrow even when you have money in the bank. For example, borrowing money can be less costly than opportunity cost. Borrowing may let you make decisions now to save money in the future, like buying a home before the interest rates go up.

Some loans also create a tax benefit. Interest on home mortgages or business loans, for instance, is deductible while interest paid on credit cards is not.

While most lenders are reliable and helpful, borrowers often let their wants outweigh their needs. They focus on the financial satisfaction instead of the means to get there. So, it helps if you do at least these three things before considering getting a loan.

1. What type of loan are you considering?

Sometimes, it seems like every bank and financial institution wants to put money in your pocket. You can even borrow online now. But, different loans serve different purposes.

• Auto Loans put millions behind the wheel of their cars, trucks, and SUVs. Few people are positioned well enough to ante up the cash to buy a quality vehicle. So, they borrow from a bank or through the auto dealership to drive away in a vehicle that depreciates quickly.
• Home Mortgages enable millions to buy their dream home or necessary shelter. Conventional mortgages offer fixed or variable interest rates, and Government agencies provide special opportunities with favorable terms through FHA, VA, and RHS loans.
• Equity Loans secure a lump sum against the equity built into a home over time. Equity Lines of Credit offer money for any purpose on the equity in the home. And, Home Improvement loans let homeowners use their equity to repair or renovate their home.
• Student Loans put millions through college and graduate school education. They are offered by commercial lenders and state and federal agencies. Ron Lieber, writing for The New York Times, warns, “Given the hopscotch manner in which students take on debt each year, loan by loan, it is much too easy to lose track of your running total.”
• Personal Loans are obtained through banks, savings institutions, and other lenders. They are Secured Loans if you use collateral or Unsecured Loans when they do not require collateral.
• Business Loans usually require presentation of formal business plans. As Rohit Aora of Forbes says, “The business plan will outline what the business is, where it is located, who is running it, when it operates and how it will achieve a profit. A well written business plan is a vital step in the process of securing a small business loan.”

Business loans might satisfy your business needs to expand your facility or growth plans, increase inventory, improve cash flow, or purchase additional equipment:

• SBA Loans from banks and other lenders are guaranteed by the Small Business Administration.
• Term Loans are contracted for a specific period,
• Short-Term Loans are repaid in one lump sum after a short period.
• Equipment Financing purchases equipment used as collateral.
• Bill Consolidation Loans help you reduce your debt structure by bringing current financial obligations under one umbrella. Consolidation reduces all your multiple payments to a single payment with a single interest rate.
• Emergency Loans satisfy unexpected financial events. People run into financial walls with medical expenses, car repairs, or problems meeting rent. Short-term or payday loans offer a quick solution.
• Vacation Loans have become more common for families wanting to invest in a travel package that covers travel, hotel, and other expenses.
• Family Loans are made among family members or friends. But, generous and empathetic as the loans may be, they risk tension and stress when the loans are not repaid as agreed.
• 401(k) Loans come from your retirement funds. It’s a relatively easy process without application forms and credit score check. But, you will be liable for tax penalties on the gains accrued while the funds were protected by the 401(k) Plan.
• Credit Card Debt is effectively money borrowed to fund your lifestyle. You draw against credit limits on credit cards to purchase goods and services with convenience and high interest rates.

You can generally consider home mortgages, small business loans, and student loans positive moves because they increase your value. But, credit cards and car loans have immediate negative impacts.

With some due diligence, you will find that each type of loan comes with its own terms and conditions.

2. What are the terms and conditions of the loan?

• Repayment Schedule: The length of the loan will contribute to the customer’s cost.because interest charges are partly a function of time. Customers are first attracted to loans with low monthly payments, but lengthening the term of the loan only increases the total cost. For example, a 30-year conventional mortgage appears to cost less each month, but the accumulated costs far exceed those for a 15-year mortgage.
• Prepayment Penalties are built into some loans to discourage borrowers from paying off early to save expenses.
• Student Loans encourage borrowers to stick with their repayment schedule because the government pays the interest as long as borrowers comply.
• Down Payments reduce the amount of principal owed. A down payment may be a loan requirement, but borrowers can pay more than required to reduce the principal on the loan.
• Interest Rates are quoted in several ways. The APR (Annual Percentage Rate) really matters. So, if you can shop for a loan, you’ll want to find the lowest APR.
• Fees are charged by lenders and can vary from one lender to another. Depending on the loan, there might be administration fees, appraisal fees, credit report fees, fees, and underwriting fees. They do not increase your principal, but they do increase the monthly payments.

3. What is your financial position?

Your ability to borrow depends on the lender’s willingness to accept your current and past financial situation.

• Your income-to-debt ratio. If you own more money than you make, you are a risk to the lender. Most lenders insist your debt-to-income ratio be less than 43 percent.
• Lenders want proof of income with pay stubs, bank statements, or income tax records.
• Most lenders will require your work history and credit score as indications of your ability to make consistent payments in the future and your payment behavior in the past.
• A consistent residence over time will show your stability.
• A substantial down payment will increase your attractiveness to lenders as well as reduce the principal on your loan.

Any loan arrangement requires you to be disciplined. Defaults and delinquencies affect your credit history permanently. Loans require you to plan, budget, and stick with it. When you need to borrow, you are thinking about how to spend. But, the lender wants to know more about your ability to pay. So, borrower and lender are rarely on the same page.

To get the loan you want, you need to take some control of the negotiation. If you wear your desires on your sleeve, the borrower has the upper hand. The more you know about the process and the competition in lending markets, they better off you are.

One last thing

All debt represents a burden. But, it’s also true that few can live their lives without it. Debt educates you, puts food in your mouth, keeps you on the road, pays your medical bills, and keeps a roof over your head.

Loans are available as long as institutions have money. But, it is a more competitive market than you might think. You have the opportunity to shop for the loan terms that best serve your needs. Lenders want clients with good credit records, the ability to pay, and a record of stable employment. Those candidates get the best deals.

But, money is still available to those in less ideal circumstances. It will come at some additional cost in the process, interest rates, and fees. Still, there are loans most people can close.

With full and unbiased information, loan customers can find resources at the most favorable terms. LoanReviewHQ, for example, provides honest, thorough reviews of loan providers including the financial institutions that provide fast cash at higher interest rates. At Fortune, Bryan Borzykowski reinforces this strategy: “The time you take to research can help you be sure that you are choosing a lender you trust and that you understand the process.”

It’s true that emergency needs can press you into the worst decisions. But, few can afford to make the wrong deal when there are real options of value available. If you must pick up the pieces, you should take a breath and follow the advice covered here before considering getting a loan.