Financial Wellness Series: The Lowdown on Loans

People borrow money for many reasons, from purchasing a home to buying a car or to cover emergency expenses. Sometimes things may be too expensive to pay for on their own in a reasonable amount of time or because something happened unexpectedly.

But is borrowing money a good thing? Well, it depends. You should avoid going into so much debt that you have trouble repaying your loan, paying your household bills, or putting money toward savings.

So, before you take out that loan, consider the way borrowing may impact your finances and get advice from a financial advisor to help you sort out the pros and cons. Also, read our blog on the Basics of Personal Finance for a refresh on good money management.

The Basics

At the most basic level, a loan is a form of credit where a lender gives a specific amount of money to a borrower, with the agreement that it will be paid back later, typically with interest. The interest is the fee charged for borrowing the money.

You may hear these key words about loans:

Loan Terms – All the agreed upon details of the loan including how much the borrower pays each month, the interest rate, and how long the borrower has to pay back the loan.
Term of Loan – The length of time it takes to repay the loan.
Principal – The amount being borrowed, which does not include any interest or fees.
Interest – The amount charged to be able to borrow money, listed in dollars.
Interest Rate – The amount charged to be able to borrow money, listed as a percentage.
APR – Annual percentage rate (APR) is the total amount the lender charges for the loaned money, including the interest rate and fees.
Down Payment – Money a borrower pays out-of-pocket to the seller towards the purchase price of the item being borrowed against, which will reduce the principal amount of the loan.
Payoff – Paying the remaining loan balance, including interest, principal, and fees.

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What You Should Consider

Before you think about getting a loan, be sure to evaluate your current financial situation. Because, if you aren’t careful, you could end up putting yourself in debt that you can’t pay back. Next, don’t go with the first bank you find – compare different lenders, do your homework, ask questions, and your future self (and wallet) will thank you.

Interest Rates

Interest rates play an important role in determining how much you pay back each month. A fixed rate will stay the same during the life of the loan so your payment should also stay the same, while a variable rate can change over time and raise your costs unexpectedly.

Length of the Loan

The loan term is how long you have to pay back a loan. Longer terms can mean lower monthly payments, but you'll pay more interest overall. If you plan to pay off the loan early, check for prepayment penalties – they can erase any savings.

Short-term loans might seem cheaper on interest but watch out for fees that can negate those savings. Also, the monthly payments may be high; make sure it’s affordable for your budget.

Fees

When you're taking out a loan, fees are almost always part of the deal and understanding these upfront is important. It helps you plan your budget and avoid unexpected costs. Different lenders and loan types come with their own specific fees. You might encounter an application fee; origination fee; processing fee; late payment fee; and more.

Lender's Reputation

Research your lender! Check reviews and ask friends about their experiences. Pay attention to common complaints. A good lender will answer your questions clearly and be easy to reach. If they're not, find a new one you can trust.

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What Lenders Consider

Not all lenders are the same, but most focus on similar things when reviewing your loan application. They're mainly looking for your ability to repay and your willingness to repay. If you understand these key factors, you can better prepare for the application process and boost your chances of getting approved.

Credit History – Your past payment behavior, how much credit you use, and how long you've had credit accounts. (Learn more about credit scores and reports in this blog.)
Income & Employment – Proof of stable earnings to ensure you can make payments.
Debt-to-Income (DTI) Ratio – How much of your income goes to existing debts. A lower ratio is better.
Assets – Your savings and investments, showing financial stability.
Collateral – (For secured loans) The value of the asset you're using as security.
Loan Purpose & Economic Conditions – Why you need the loan and how the economy might affect repayment.
Loan Amount – Is the amount you're asking for reasonable based on your finances?
Down Payment – A larger down payment shows responsibility and reduces the lender's risk.

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The Loan Process

Navigating the loan process can feel a bit daunting, but it's actually pretty straightforward! Each step is key to getting your loan approved and handled smoothly. While the unknowns might seem scary, the core steps for credit approval are quite similar, no matter what type of loan you're after.

Here's a breakdown of the typical loan process:

Part 1: Your Application

First, you apply for a loan. You'll provide personal and financial details, including why you need the loan. The lender then reviews this information, especially your debt-to-income (DTI) ratio, to see if you can repay it.

Part 2: The Decision

Based on your creditworthiness, the lender will either approve or deny your application. If denied, they must tell you why. If approved, you both sign a contract outlining the loan terms, including interest and how long you have to repay the loan. The lender then pays out the funds.

Part 3: The Terms

Loan terms are agreed upon upfront. If collateral is required, it's noted in the documents. Most loans also detail the maximum interest and other agreements, like the repayment timeline.

An Important Word About Pre-Approval

Loan pre-approval means a lender has conditionally determined you're eligible for a loan based on an initial financial review and a soft credit check. This gives you an estimated loan amount, interest rate, and terms, but it's not a guarantee of final loan approval. (You may hear the terms pre-approved and pre-qualified. They’re similar, but different. Learn how.) Getting pre-approved is an important step for auto loans and mortgages. Why? It gives you a better idea of what price range you can afford before you go shopping for that new ride or home.

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Final Thoughts

Deciding whether or not to take out a loan is a big financial decision that requires careful consideration. Approach it wisely to make an informed decision.

You may not need a loan at all. Review your finances and see how you can manage your money to afford what you want without going into debt.
Thoroughly read your loan contract. It’s legally binding and impacts your finances. If you don’t understand something, ask questions.
Financial hardship can make any cash seem appealing, but beware: some loans come with predatory fees and interest rates designed to trap you in a cycle of debt. It's best to avoid these types of loans.
A credit card is a type of loan which also requires you to make payments and can involve fees. Learn how a credit card is different than a personal loan.

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Borrowing money can help with major purchases or emergencies, but it's crucial to understand loan terms and avoid excessive debt to maintain financial health.

Next month in our Financial Wellness Series: Paying for College
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Financial Wellness Series: The Lowdown on Loans

People borrow money for many reasons, from purchasing a home to buying a car or to cover emergency expenses. Sometimes things may be too expensive to pay for on their own in a reasonable amount of time or because something happened unexpectedly.

But is borrowing money a good thing? Well, it depends. You should avoid going into so much debt that you have trouble repaying your loan, paying your household bills, or putting money toward savings.

So, before you take out that loan, consider the way borrowing may impact your finances and get advice from a financial advisor to help you sort out the pros and cons. Also, read our blog on the Basics of Personal Finance for a refresh on good money management.

Table of Contents

The Basics

At the most basic level, a loan is a form of credit where a lender gives a specific amount of money to a borrower, with the agreement that it will be paid back later, typically with interest. The interest is the fee charged for borrowing the money.

What You Should Consider

Interest Rates

Length of the Loan

Fees

Lender's Reputation

What Lenders Consider

The Loan Process

Navigating the loan process can feel a bit daunting, but it's actually pretty straightforward! Each step is key to getting your loan approved and handled smoothly. While the unknowns might seem scary, the core steps for credit approval are quite similar, no matter what type of loan you're after.

Here's a breakdown of the typical loan process:

Part 1: Your Application

Part 2: The Decision

Part 3: The Terms

An Important Word About Pre-Approval

Final Thoughts

Deciding whether or not to take out a loan is a big financial decision that requires careful consideration. Approach it wisely to make an informed decision.

Borrowing money can help with major purchases or emergencies, but it's crucial to understand loan terms and avoid excessive debt to maintain financial health.

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