Did you know that in the first half of 2018, lenders mailed some 1.26 billion personal loan solicitations?
That’s a lot of solicitation letters!
This may help explain how Americans ended up owing $125.4 billion in personal loans in the second quarter of 2018.
Another possible reason is the increase in credit application rejection rates that year. After getting turned down for credit, many applicants turn to personal loans instead.
If you find yourself in the same boat, or you seriously need money now, you’re likely thinking of applying for a loan. But before you do, make sure that you first understand what a loan entails. This way, you can make an educated decision on which loan is right for you.
Ready to become a responsible and smart borrower? Then read on to learn more about loans and what to do before taking one out!
Know Your Credit Score
An applicant’s credit score is one of the key factors that lenders consider. This is especially true in the case of traditional lenders, like banks and credit unions.
One reason is that a person’s credit score is an indication of repayment ability. It also shows lenders that a consumer pays their debts and credit obligations on time. So, the higher a loan applicant’s credit score is, the lower the risks that lenders take on.
For borrowers, this means that their credit score affects their loan’s approval rate. The higher a person’s credit score, the greater their chances of getting a yes from a lender. Excellent scores also land borrowers more favorable terms, such as lower interest rates.
So, how’s the U.S. doing in terms of credit performance?
Conversely, lower credit scores equate to higher interest rates. People with very poor credit scores may not qualify for any loan at all. In fact, back in 2017, poor credit scores were the reason why 32% of loan applications were denied.
If you’re unsure of where your credit stands, don’t hesitate to request a copy of your credit report. It’s free, and it’ll allow you to check for any discrepancies in your report. You’d want to dispute and get those possible errors fixed before applying for and taking out a loan.
Always Compute the True Cost of a Loan
Let’s say you already know your current credit score or you don’t have time to wait for the copy of your report. Even in cases like this, you should still take time to compute the total cost of each loan offer you get.
Even a 1% difference in interest rates can make a big difference. Getting a 1% lower interest rate can save you hundreds and even thousands if you take out a major loan.
For simplicity’s sake, let’s use a $1,500 loan with a six-month term as an example. Lender A charges a monthly 7% interest rate, while Lender B charges a monthly 8% interest rate.
With Lender A’s offer, your interest payments would be $105 a month, or a total of $630 for six months. Your monthly loan payments will be $355, which means that in total, you’ll pay back the lender $2,130.
If you miss out on Lender A’s offer and go with Lender B, your monthly interest payments will be $120, for a total of $720. Every month, for six months, you’ll make a payment of $370. At the end of your loan term, you would have paid the lender $2,220.
That’s a considerable difference of $90. That’s money that you could’ve otherwise saved if you compared even just two loan offers. Imagine how much more you can save if you compare three or more!
Factor in Your Repayment Ability
Now that you know how the basic loan payment structure works, let’s talk about your ability to pay back a loan.
For this, you’ll need to deduct your monthly expenses from your take-home pay. Let’s say you make $3,000 a month, and your expenses are $2,500. This means you have an “extra” $500 a month.
If you take out a loan with the exact terms we used in the above example, then you would be able to pay it back. Of course, it’s always a good idea to put away whatever you can into your savings account. But if you’re in dire need of cash now, then technically, you can afford to take out a loan similar to our example.
But what if your salary “left-over” is equal to your estimated monthly loan repayment?
In that case, you’d end up stretching your finances too thin, and you’d be at risk of coming up short once your loan due is up. This may force you to take out even more debt to avoid defaulting on your current one.
To avoid this, it’s best to take out a loan that has a smaller principal. A smaller loan amount will translate to smaller monthly payments. You’ll also pay less interest over the life of your loan.
If you can’t afford to get a smaller loan amount, then at least get a longer-term loan. This comes with lower monthly payments, so it’s easier to pay back every month. However, since you’ll stretch your payments over more months, you’ll also be in debt longer.
Prepare Your Financial Documents
Speaking of salary, you’ll need to provide proof of income and employment to lenders. This goes for both traditional and online lenders.
Online lenders usually ask for fewer documents, which may either be a salary letter or pay stubs. Whereas banks require both, plus W-2 forms.
If you have a side job or also take on freelance jobs, be sure to provide proof for these, too. They add to your income, so they can help boost your chances of securing a loan.
If you’re self-employed, prepare at least two years’ worth of tax returns. Gather receipts, invoices, bank statements, and proof of assets. All these can help prove your ability to pay back a loan.
Lenders will also ask you for government-issued IDs, including drivers licenses and passports.
Don’t Lose Hope if One Lender Turns You Down
Just because one lender rejected you doesn’t mean the next one will. Banks and credit unions aren’t your only option, as there are now more than 200 digital lenders in the US.
That said, you may want to give these lenders a go if a bank denied your previous application and you need money ASAP. They have looser lending requirements, so their loans are easier to qualify for. It’s also due to their more relaxed policies that 38% of approved personal loans in 2018 came from them.
Always Verify the Legitimacy of Online Lenders
Before you apply for a loan online, confirm that a legitimate company is behind the website. Looking up a lender’s registration or license is one way to do this.
Note that each state has its own regulations, but they do require lenders to be a registered business.
For example, in Texas, the law requires lenders like tiempoloans.com to hold a license. They also need to register with the Office of Consumer Credit Commissioner of Texas. Before a lender can get licensed, it must satisfy everything in the state’s finance code.
Other states follow similar lending regulations, so it’s best you know your state laws. This way, you can avoid shady businesses or paying exorbitant interest rates.
Consider Borrowing Against Your Assets if You Need Money Now
If you have no or low credit score, but you have valuable assets, consider applying for a secured loan. In this case, your asset, say a vehicle in great condition, can serve as collateral. Collateral reduces the risks for lenders, so they’re more inclined to approve a loan.
Before you accept a secured loan, make sure that you can really make the repayments on time. Defaulting on this kind of loan can mean losing your property. The lender will liquidate the collateral so they can recover the money they lost.
Never Borrow More Than What You Can Pay Back on Time
This may seem obvious, but the fact is, loan delinquencies are still very common. Just take the 7 million Americans who have serious delinquencies on their car loans. Forbes reports that 11.4% of the 44.7 million student loan accounts are now also on serious delinquency status.
Loans are no doubt helpful, but they can lead to long-term debts. So, be careful when borrowing money. Even if you get approved for a high amount, make sure you can afford to pay it back. If in doubt, take out a lower amount.
Start Shopping Around for the Best Loan Now
There you have it, your in-depth guide on loans and how to ensure that you can pay them back. Even if you need money now, hold your horses for a bit longer so you have more time to explore your loan options. This way, you can compare interest rates and terms and determine which loan offer is best for your needs.
Need more help figuring out your expenses or how to pay back your debts? Then don’t forget to check out and bookmark our site’s Spending Plan and Debt Management pages!