Certain purchases in this world are out of the price range of most Americans, at least to purchase in one lump sum. These include things like an automobile, home, education, a business, and even large equipment. For these types of purchases, many people will require a loan to make the dream a reality. A loan is nothing to be afraid of and can actually be beneficial if you can afford the payments. However, obtaining a loan is a process that requires you to be prepared and have financial documents in order.
What Types of Loans Can I Obtain?
There are many reasons to get a loan and many types of loans that can be obtained. First, there are secured loans. These are loans that are secured by collateral. For instance, an automobile loan uses the automobile for the collateral. The following items are typically purchased with a secured loan:
- Home (Mortgage)
- Recreational Vehicle
- Business Equipment
- College (Student Loan)
In contrast, an unsecured loan does not maintain any collateral. This means that if a person does not repay the loan, the lender has limited actions he or she can take to replace the money. These loans are typically smaller and require better credit and more credit history. Types of unsecured loans can include student loans and business loans, to name the more common loan options.
What is Required to Obtain a Loan?
Whether you are looking to obtain a secured loan or an unsecured loan, you must show you have creditworthiness. In many cases, you will have to show pay stubs at the very least. For most loans, aside from automobile loans, you will have to give copies of tax returns, access to your credit report, proof of identity, and even proof of address in the form of household utility bills or other household-based loans.
A secured loan will often require a little less from you than an unsecured loan, unless you are obtaining a mortgage. Due to the issues with sub-prime (below credit market) mortgages in the early part of the century, mortgages have very strict guidelines.
Typically, obtaining a mortgage is almost as difficult as obtaining an unsecured loan, except you will be approved for more money for a mortgage than an unsecured loan.
Jumping back to the requirements of a secured loan, typically, your credit score can be a bit low (below the 700 mark), and you can still qualify for a secured loan. In addition, the loan will be for the amount of money needed to cover the cost of the secured item. Instead of denying the loan or lowering the amount of the loan, a secured loan will often come with a higher interest rate if you are not a perfect credit risk.
For an unsecured loan and a mortgage, you must show that you have creditworthiness. This means you typically need to borrow the money when you do not need it most. That is when your debt to income ratio is low, and your credit score is typically high. The main differences between an unsecured loan and a mortgage are that the mortgage is for hundreds of thousands of dollars. And, some variations allow people with items like a bankruptcy or some other credit issues to still obtain a mortgage, although mortgage insurance may be a necessity. In the case of an unsecured loan, if your credit is not highly rated, you will likely be denied the loan.
What Is the Purpose of Interest and How is It Calculated?
As mentioned above, interest may be lower or higher, depending on your creditworthiness and credit score. However, you may be wondering what interest is and how it is calculated. Interest is a percentage added to the loan that allows the lender to make money on the loan. It is basically a fee to the lender. Interested is added to the final payment structure of the loan based on the lender’s calculation and is usually accrued over time.
Therefore, if you pay a loan off early, the payment will likely be less than if you paid it off on time. This is because you pay less interest if you have the loan for a shorter period of time.
Interest is calculated based on a series of requirements and factors. Your credit score plays a large part in this calculation. Another piece to the puzzle is the standard set by the Federal Reserve and Banking Commission regarding interest rates. This usually provides a starting point for interest rates on secured loans. As the rate rises federally, your interest rate may rise prior to singing and securing the loan.
Finally, other factors will play into the way in which interest is calculated, such as the length of the loan and whether there is collateral for the loan. Once this is all figured into the calculation, an interest rate will be assigned to your loan, and you will receive the final paperwork that will include the interest amount and total payoff amount.
How Do Payments for a Loan Work?
Paying back the loan is key to taking out any type of loan. Every loan payback system is fairly similar. The payment is set up to be paid monthly unless otherwise specified. The monthly payment is divided as follows:
- The first portion of the payment is paid towards interest.
- The second portion of the payment is applied to the principle.
The interest is always paid first. Therefore, if you miss a payment, your next payment will pay the interest, the late fee, and then the principle of the loan. If you double payments, the interest will be paid before the principal, unless you specify otherwise.
Taking out a loan and understanding how it works is a difficult process. It can be confusing, and if you are not careful, you could pay a lot more money to pay it back than necessary. That’s why it’s important to read all the terms before committing to any loan from a financial institution.