How To Determine Which Loan Is Right For You
Applying for a loan can be a stressful experience for the inexperienced borrower. Contracts a mile long, clauses, and esoteric penalties often make people feel like they’re in over their head, however a bit of careful planning puts you in control of the entire process and enables you to make the right decision for your needs. Whether you need a loan for a car, home repairs, or even a small business, the principles for finding a great loan and avoiding bad deals remain relatively the same. The following guide will help get you thinking about the the loan that’s right for you, and how to go about securing it.
What Do You Need The Loan For?
Banks and private lenders structure loans differently depending on how they will be used, meaning that the reason you need a loan will determine which type makes the most sense. Many people who are inexperienced with debt mistakenly believe that a $10,000 loan for a new car is no different than a $10,000 loan for a business venture. In reality, loans for different purposes carry significantly varied interest rates, repayment terms, and penalty clauses, usually based on the borrower’s history and goals for the money.
When shopping for a loan, focus your research strictly on loans related to your goals. Ask your lender about arrangements the suit your purposes, and disregard irrelevant options that are not intended for your purposes.
Determine Your Debt To Income Ratio
Your debt to income ratio is a measure of the amount of debt you can reasonably assume given your level of income. It isn’t enough to just decide you want $15,000 for the downpayment on a condo, because your current outstanding debts and income level may reveal that you cannot responsibly service that amount in new debt. Debt information resource CareOneCredit reports that “most banks and financial professionals agree that you should keep your debt-to-income ratio at less than 36 percent of your gross income.”
By not knowing your ratio before applying, you could waste a great deal of time and effort pursuing loans that you neither qualify for nor have the ability to comfortably repay. To find your ratio and determine how much new debt you can afford to take on, check out the free online calculator at CreditSoup.com. First, calculate your current ratio, and then do a second calculation with the loan you are considering added in. If the ratio is still under 36%, you are on the right track.
What Interest Rates Are Available To You?
Some loan shoppers make the mistake of instinctively choosing the bank their regular bank as their lender without shopping around for a better rate. Financial and legal resource FindLaw urges borrowers to take their time and shop around for a low interest rate, as they can vary significantly between lenders. “Since lenders are competitive, it pays to compare what several have to offer,” they advise.
Indeed lenders will generally compete for your business, especially if you have excellent credit score. One lender might offer a lower interest rate in exchange for some upfront lender fees (known as points) while others will waive these fees and charge a higher rate. Only you can decide which arrangement is right for your situation, but in order to discover your options you must look around.
Fixed Rate Or Adjustable Rate?
Interest alone isn’t the only big consideration to make when selecting a loan, you must also check the interest type. Fixed rate and variable rate loans are totally different animals, each carrying its own unique benefits and risks. A fixed interest rate will not vary over the term of the loan, so the amount of interest you in month one will be the same on the day you make your final payment. This major benefit with a fixed rate is piece of mind – if interest rates go up over the course of the loan, you will never be subjected to them.
Of course, if interest rates fall, your fixed rate does not fall with them. This is the gamble of the variable rate – an interest rate that can adjust to the current rate at any time over the term of the loan. If rates go up or down, so will yours, and you will reap the benefits or deal with the consequences every month.
Check For An Early Prepayment Penalty
Whenever possible, you should strive to avoid all loans with prepayment penalties. A prepayment penalty is exactly what it sounds like – a hefty financial penalty that makes it undesirable for a borrower to repay a loan before its due. These penalties are sometimes put in place to ensure that the lender reaps the full profit potential of the loan. Paying off your principal early means that the lender must take a substantial hit on interest, which is where they make their money.
This is bad for you, however, because your goal is never to be in debt for as long as possible. If your loan has a term of 36 months, but you devise a budget that allows you to pay it in 24 months, you should always retain the option to do so without penalty.
Loans For Small Businesses
If you’re a business owner and need a loan to get started running running your company, there several routes you can take to obtain the financing you require. Like most other loan types, banks issue small business loans to qualified applicants, however there are other options available to entrepreneurs. The Small Business Association, for example, works with a network of lenders and is committed to helping business owners find and secure the loans they seek.
Specific populations are eligible for small business loans as well, including veterans and women. VeteransToday reports that The Veterans Association (VA) offers small business financing to to veterans of war, and often provides an easier approval process and favorable terms for approved applicants. Female entrepreneurs are eligible for special financing programs and grant options from private organizations. WomanOwned.com offers a helpful resource for finding and applying to these programs.
This is a guest post from Whitney Freestone. Whitney is a freelance writer for Wells Fargo. Use Wells Fargo for a bill consolidation loan or to apply for a car loan refinance. Visit the website to learn more of how Wells Fargo can help you save money.
Photo credit: Casey Serin
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