Taking out a loan is a serious financial decision, so you need to be smart when making it. Ideally, we should be able to dive into our emergency savings when something unplanned happens, but statistics show we are not as good at saving money as we may think.
This is why, when they find themselves in the middle of a financial issue, many people choose to take out a personal loan to cover these emergencies, pay for unplanned medical bills, or make an important purchase that can’t be postponed.
Because taking out a loan represents an important decision, you need to make sure you have a very clear idea of what you are getting involved in. By taking into consideration all the factors associated with a loan, you can avoid costly mistakes such as borrowing more than you can afford to pay, selecting a bad lender, or agreeing to some unfavorable conditions.
To help you get a better understanding of the process, we have put together this list of advice that aims to prepare you for taking out the much-needed loan.
The reason for taking out the loan
The first thing you need to be clear with yourself about is why you plan on taking out this loan. As we mentioned, this is an important financial step, which means if you do it wrong, it can hurt your financial stability quite a bit.
One of the main reasons people take out personal loans is to cover up an emergency expense, such as bills, medical payments, a flooded basement, or a broken car. If this is your case and you don’t have an emergency fund to dive in, taking out a personal loan seems to be the most convenient option.
If, however, the reason you need to take out the loan does not represent an emergency and could wait a few more months, then you may want to reconsider your decision. Instead of taking out an expensive loan and paying interest on it, you can save up the money for this purchase over the following months.
The loan options available
If you decide the situation can’t wait and you must take out a loan, it’s time to evaluate your options. The most obvious choice for most people is to go to the bank they already have an account with and discuss loan options.
While this is a convenient method that makes managing payment a little easier, it may not always be the best financial choice. Before you go on signing a new agreement with your bank, do your research and see if there are more convenient options available. There are many online financial directories that can help you find affordable and convenient loans, and some of these lenders often have less stringent requirements than banks and financial institutions. Some of them even offer payday loans, which are small loans that are given instantly and need to be paid back within a couple of weeks. If you only need a couple hundred dollars to cover an unexpected expense, this may be a more suited solution.
How much money you can realistically afford
Once you have determined where to get the money, you need to figure out if you can afford to loan the amount you need. This part is quite tricky because even if you are able to cover the monthly payments, it does not necessarily mean you can afford the loan. This goes hand in hand with a study conducted by Harvard University, in which they were able to find out 40 million US citizens don’t actually afford the homes they live in. This means they would not be able to cover a $500 house emergency if it appears.
This is not meant to discourage you from taking out the loan but rather to make you reconsider what you understand by affording to borrow this money.
To get a clearer idea of whether you can or can’t afford the loan, you need to think beyond the APR (annual cost of a loan to the borrower) and consider the total amount repayable for the loan (TAR). The TAR is basically the borrowed amount, plus interest and other fees you are about to pay. Do this for every option you have and choose the one that ends up costing you less in the long run.
Details about your credit history and score
Credit scores and histories can be tricky to manage, so once you have determined how much money you need to borrow, it’s time to see if your credit score qualifies you for it.
A good credit score brings with it lower interest rates, smaller payments, and more opportunities for saving, so you need to monitor it constantly. Many people go through life not knowing their credit score, only to be hit with a refusal when they need to take out an emergency loan. If you care about your financial situation, you need to know this aspect just as well as you know your salary.
You can use an online tool to estimate your credit score and get a better idea of where you are standing, but as a consumer, you are also permitted to request a free copy of your credit report from the credit bureaus in the country. This applies to the United States and Canada as well.
The terms of the loan
Assuming you followed all the steps above, you are now in the midst of signing up for a personal loan. Before you offer them your signature, ensure you understand the terms of the loan entirely. This includes the annual percentage rate, the total repayable amount, as well as any other fees you may be required to pay.
It is not uncommon to find out there are some hidden fees that were not exactly discussed openly with you. Here are some examples:
- Loan processing fee – some lenders charge a fee to process the loan; usually on a percentage basis
- Prepayment penalty – fees charged if you decide to pay the loan off earlier than the agreed date
- Failed payment fee – penalty charged if you made a payment but didn’t have enough money in your account to cover it
- Late payment fee – fees charged if you make your payment late. This can also hurt your credit score
Obtaining a loan is a significant financial step that should not be handled carelessly, so it’s crucial to understand what you are doing, as not to regret your decision. When you’ve decided to take out a loan, make sure you choose the correct lender with the most flexible conditions.