Understanding Loans: Part 2 – Know This Before Taking Out Any Loan

This blog post is the second in a three-part series. Read Part 1: How Loans Work and Part 3: PATF Loan Terms Matter.

If you must make an important purchase (for something you need) and you simply don’t have the money to pay for it upfront, a loan can be a helpful option. Of course, borrowing money is not to be taken lightly, as too much debt can be a burden that can have a big impact on your monthly expenses. One way to get out in front of a potential debt drain and not get in over your head is to get the best deal possible when you are applying for a loan.

In the Part 1 – How Loans Work blog post, we outlined what a loan is, when a loan might be a good idea, and some of the benefits that come with borrowing money. In this post, we will outline some questions you should ask to determine if a loan is truly affordable for you. As not all lenders are the same it’s vital to compare the loan terms and interest rates. You have a 14-day window to shop for the best loan rates and terms, all applications during this period will only count as one hard inquiry. Your credit score will always be negatively impacted whenever you are applying for a loan, whether you get the loan or don’t get the loan

When you are shopping for a loan, the following are some essential questions you should ask and get answered:

1. Loan amount: How much money can you borrow from this lender, and is it enough to cover what you need? Keep in mind that a loan doesn’t have to cover the total amount of the purchase – if you have money saved for this purchase, or if you have alternative funding sources, you can take out a partial loan to pay the balance.
2. Fees: Are there any upfront fees (like application or origination fees), ongoing fees (like monthly or annual fees), or other fees (like prepayment fees or check processing fees)?
3. Interest rate: What is the interest rate? Is it fixed or variable (see below for definitions)?
4. Loan terms: What are your options for the total length of time you have to repay the loan? Generally, a longer loan term has lower monthly repayment amounts, but a higher total amount paid in the end.
5. Repayment amount: How much will you be obligated to pay each period as part of your repayment plan? You can use a loan calculator (you’ll find one on our homepage) to determine what your monthly payments will be by entering your total loan amount, loan terms (how many months), and the interest rate.
6. Repayment terms: What are your options for a repayment schedule (usually payments are made monthly, but occasionally you’ll have other options like weekly)? Can you make extra repayments or repay the loan early without a fee?

Some helpful terms you know when researching your options for a loan:

• Fixed-rate loans: These loans keep the same interest rate throughout the life of the loan.

• Variable-rate loans: These loans have an interest rate that varies over the life of the loan. It may go down or up based on certain benchmarks.
• Secured loans: These loans are backed up by property you own, like your house or car, as collateral. If the borrower fails to make payments for a certain period, the lender may opt to “repossess” the property. Most lenders offer secured loans as a way of protecting themselves when the loan amount is either very high or when the borrower’s credit score is low enough to be considered a credit risk.
• Unsecured loans: These loans do not require any collateral, often have higher interest rates, and may be difficult to obtain if you have a low credit score.

Guaranteed Loans v. Non-guaranteed Loans

A guaranteed loan is when there is a promise by a third party (not the borrower or the lender) to take responsibility for paying off the loan if the borrower defaults.  A guaranteed loan may be offered to an applicant if one of PATF’s partner banks is unwilling to extend a loan to them.

A non-guaranteed loan does not have a third party promise to pay the loan if the borrower defaults (fails to pay the loan according to the agreed-upon loan terms). This type of loan is usually only available to borrowers with good to excellent credit scores and low debt-to-income ratios.

What Do Lenders Look At?

Most lenders follow lending guidelines or a list of qualifications you need to meet to take out a loan (you can find PATF’s on our Financial Loans page). Lender qualifications also affect the type of loan available, the interest rate, and the loan terms. Lenders primarily look at your credit score and debt-to-income ratio (the percentage of your monthly income that goes toward paying off debts). They may also consider such information as your employment status and length of time you have lived in your residence. While you may be able to get a loan with a low credit score and a high debt-to-income ratio, your interest rate will likely be higher (costing you more money in the long term), you may need collateral (putting you at risk of losing your asset if you default on the loan), and you may need a guarantor (which is not always an option). (Learn more about credit, how to build it, and how to manage your debt.)

So, you’ve asked the important questions and gathered the necessary information – you’re ready to choose a loan! But it’s not as simple as comparing interest rates and monthly repayment amounts. Part 3 of this series will look at an example of how the repayment cost of a loan for the same adapted vehicle can differ, as we discuss why the loan terms and conditions matter!